Tokenization: The Next Step in the Evolution of ETFs?

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The global ETF market has reached a new record in assets under management, driven by strong market performance and a clear investor preference for these vehicles. According to EY’s latest report on this industry, two clear trends have emerged in the past decade: the development of active ETFs and the entry of ETFs into the crypto asset universe. Could tokenization be the next step in this evolution?

“Digital assets are starting to gain traction, particularly with the SEC’s approval of spot bitcoin ETFs, which could begin to pave the way for asset tokenization, though challenges in liquidity and settlement mismatches persist. Efforts to shorten settlement times could accelerate the trajectory of tokenization in ETFs,” the report notes. The approval of spot bitcoin ETFs was followed by the green light for vehicles investing in Ethereum this past May.

According to the EY report, investor interest in digital assets and tokenization is on the rise. In fact, the consulting firm believes that in recent years, significant progress has been made as financial markets move in this direction. “ETFs physically backed by digital assets have been present in European markets for several years, offered by providers like Shares and ETC Group, allowing market participants to trade this asset class on European exchanges, albeit with certain distribution restrictions. In January 2024, the SEC also recently approved applications for 11 spot bitcoin ETFs submitted by companies like Fidelity and Invesco, as well as the conversion of Grayscale Bitcoin Trust into an ETF. This approval fundamentally changed the shape of this industry segment, shifting from being mostly unregulated, operating out of Europe with less than $13 billion by the end of November 2023, to being primarily regulated, operating out of the U.S. with nearly $53 billion by the end of January 2024,” the report explains.

In Europe, the European Commission is conducting a comprehensive review of the directive on eligible assets for UCITS. According to EY, this review could potentially open the door to digital assets in the future, though UCITS diversification requirements would mean that single-exposure products (like the SEC-approved spot bitcoin ETFs) would remain as ETPs in Europe, similar to commodity products and single-stock exposure products.

“However, the SEC’s approval of these products is fundamental and will see wider adoption and greater familiarity with digital assets among conventional financial market participants,” the report adds.

In its assessment, hailed as the next revolution in financial markets, this movement will undoubtedly drive what comes next for the industry. “It remains to be seen whether this is the approval of another trendy product or a further step toward tokenization across the asset management industry. And with this, questions arise about the longevity of the ETF wrapper, given that real-time settlements will come into play,” they suggest.

According to EY’s analysis, while the transition of ETFs into a tokenized product will occur in the medium to long term, the industry is already working on efforts to accelerate settlement across the value chain. “In May 2024, the U.S. and Canada will move from T+2 to T+1 in securities settlement times. To shorten settlement cycles, providers have been working to enhance their trading systems and automate manual processes wherever possible, ultimately bringing operational efficiencies, cost savings, and reduced settlement risk,” the report indicates.

In their view, this will have a profound impact on the global ETF industry: “It will create liquidity mismatches between ETFs traded in Europe (with T+2 settlement) and their U.S. securities portfolios (with T+1 settlement), or ETFs traded in the U.S. (with T+1 settlement) and their European securities portfolios (with T+2 settlement). This adds additional financing costs to their commercialization, as authorized market participants for these ETFs will need to bridge the gap between the primary and secondary market settlement cycles. Once T+1 settlement becomes routine in the U.S., and market participants operate on a shorter cycle, we expect calls for Europe to follow suit, and the European Securities and Markets Authority (ESMA) is already consulting on this.”

In this sense, they recognize that Europe is a much more complex trading market than the U.S., with multiple stock exchanges, currencies, languages, and legal systems. Shortening settlement time will be much more difficult than in the U.S.,” they believe. However, once this is done, will investors demand the industry to shorten the cycle again? “Tokenization could be the next step if the industry seeks to further accelerate the cycle and offer a solution for real-time settlement. The broader asset management industry is looking at tokenization to increase efficiency and liquidity in trading alternative assets (such as private equity or fixed income) and unlock new sources of capital,” they argue.

In fact, EY points out that some providers have been exploring pilot projects to tokenize fund issuance and work on commercial, legal, and technological challenges before expanding this effort. “The FCA in the UK has announced that it is working with the industry, and the Investment Association in the UK recently published a roadmap for implementing tokenization in this area. Tokenization has the potential to fundamentally change the asset management ecosystem. It could enhance settlement speed and open new avenues for both investors and ETF managers,” they conclude in their report.

XP Expert, the Unmissable Conference, Witnesses the Duel Between Bernal and El Erian

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The largest investment conference in the world was held in São Paulo without much international attention, with Brazilians as the protagonists of their own achievement. More than 50,000 people and 250 exhibitors participated on August 30 and 31 in XP Expert, an event that showcases both quantity and quality, culminating in a showdown of experts: Alberto Bernal and Mohamed El-Erian.

The main peculiarity of XP Expert is that it should be unmissable, but the world doesn’t seem to know it, and even the Brazilians themselves don’t seem to care much. While XP’s domestic market is enough to amass a trillion reais in assets under management ($0.18 trillion), the scale of the proposal from both local and international asset managers is overwhelming, as is the event’s openness to global investment analysis and guest speakers.

The Inevitable Recession vs. A World with Five Years of Inflation

Alberto Bernal, Chief Strategist at XP Investments, strongly defends his position, kicking off his presentations with bold statements: “The pandemic didn’t change anything from the market’s perspective,” and we will return to low interest rates because the recession is already starting to show signs in the United States.

In the U.S., pandemic savings-driven consumption is depleting, job growth is slowing, and the statistics are lagging, hiding a disinflationary process that is greater than what is publicly reported.

For Bernal, a crisis or recession in the U.S. is inevitable. However, he argues that “it will be a different kind of recession, where families will still go out to eat but won’t order dessert to avoid spending too much.”

He also predicts that Donald Trump will win the next U.S. elections, favoring investment in small-cap companies. When asked if Trump would be inflationary, Bernal disagrees, saying that the Republican’s promise to reindustrialize the U.S. won’t be realized, nor will the retreat of globalization.

Just hours after Bernal’s talk, Mohamed El-Erian, Chief Economic Advisor at Allianz, presented a starkly different market vision. According to El-Erian, more inflation is expected over the next five years “because we live in a fragmented world.”

COVID-19 changed everything, creating a global consensus on the need for regulation and reindustrialization—both inherently inflationary processes.

El-Erian sees major transformations ahead in areas like life sciences, the environment, and technology: “The only way out for the world is to increase productivity and growth,” and improve wealth distribution.

“Everything is moving very quickly, and the proof is that when you ask tech leaders what the world will look like in the coming years, they admit they don’t know,” El-Erian added.

El-Erian didn’t comment on the upcoming elections but warned that if wealth isn’t properly distributed, frustration and anger will rise, undermining democracy through negative voting.

All Against the Fed, as If It Were So Simple…

Bernal and El-Erian shared one common point: both criticized the Federal Reserve, though for entirely different reasons.

Bernal believes the Fed is lagging in lowering interest rates, noting that there is too much liquidity in the market.

El-Erian, on the other hand, thinks the Fed’s biggest recent mistake was labeling inflation as “transitory.” He argues that we have inherited a market overly focused on monetary policy, a result of the 2008 crisis and massive central bank intervention.

Now, markets want governments to intervene less, which will only be possible through significant transformations. El-Erian doesn’t foresee a crisis or recession but warns of “damage” if growth fails to offset the enormous fiscal deficits of governments.

How to Invest?

Bernal, in his bold presentation, ventured to provide specific investment recommendations. He advised extending fixed-income durations, looking at low-coupon bonds—“the Microsofts or Googles”—and predicting they would yield rewards in a few years.

El-Erian took a more general approach to asset allocation, emphasizing that future liquidity will be more expensive. He posed two key questions for any investor: How resilient is my portfolio? And how is the world changing? Keeping an open mind will be crucial.

In the coming months and years, we’ll see whether these analysts’ predictions hold true. In one of the booths, a life-sized photo of someone who was always certain of his bets stood tall. That person had just turned 94 during XP Expert: Warren Buffet, with his famous quote, “Rule number 1: Never lose money. Rule number 2: Never forget rule number 1.”

BBVA Receives Green Light from UK Regulator to Take Indirect Control of a Banco Sabadell Subsidiary

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New advances have been made in the approvals for BBVA’s takeover bid (OPA) for Sabadell. The UK Prudential Regulation Authority (PRA) has given the green light for BBVA’s indirect acquisition of TSB Bank plc, Banco Sabadell’s UK banking subsidiary.

According to the bank, this authorization is one of the conditions tied to the purchase offer for Banco Sabadell’s shareholders and a necessary step to complete the deal, as TSB would become part of the BBVA Group.

BBVA submitted a purchase offer for Banco Sabadell shares to its shareholders on May 9th, and the process will begin once the necessary regulatory approvals are obtained. “Since then, BBVA has received approval for the operation from the competition authorities in several countries where Banco Sabadell operates (the United States, France, Portugal, and Morocco). The UK Prudential Regulation Authority, responsible for supervising around 1,500 entities, including banks and insurers, oversees TSB Bank, which is owned by Banco Sabadell,” BBVA explained.

Additionally, this authorization follows the Spanish regulator CNMV’s acceptance of the takeover bid for processing, “understanding that the prospectus and other documents submitted, following complementary documentation and modifications registered on 06/04/2024, comply with the provisions of the relevant article.” This does not mean the operation is final, but regulatory steps are being taken, as is customary in such cases. As Sabadell noted before the summer, the final decision will depend on the will of the shareholders.

Among the next steps before launching the purchase offer to Banco Sabadell’s shareholders is the approval of the offer by the European Central Bank (ECB) and the Spanish National Securities Market Commission (CNMV). Furthermore, the offer is conditioned on acceptance by the majority of Banco Sabadell’s share capital (a minimum of 50.01%) and approval by the Spanish competition authority (CNMC).

The Investment in Alternatives by AFOREs Is Growing in Amount, but the Percentage Remains Unchanged

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As the assets under management by AFOREs have increased, the resources allocated to alternative investments have also grown. However, the percentage these investments represent in the portfolio at market value remains low, not yet reaching double digits on average for all AFOREs, currently standing at just 7.8% of the $359 billion they manage (as of June 30). If commitments are considered, the percentage is higher, as only 58% of these commitments have been called.

To reach this 7.8%, in nearly six years, there has only been a 1.7% increase relative to assets under management (from 6.1% in 2018 to 7.8% in June 2024) when comparing in dollars. This equates to an average annual increase of 0.28% over six years. However, when looking at the growth in assets and alternative investments, the amounts are significant.

Over the past three years, the weighted percentage of AFOREs’ investment in alternatives has stabilized between 7.5% and 7.8%, with some individual cases sometimes approaching or exceeding 10%, while others are slightly above 4%.

Investments in alternatives rose from $10.3 billion at the end of 2018 to $27.8 billion by June 2024, representing a 2.7 times increase relative to the percentage growth during this period.

The assets under management by the 10 AFOREs ended June at $359 billion. The compound annual growth rate (CAGR) over five years (2018-2023) is 15.1% in dollars, while alternative investments had a five-year CAGR of 19.9%, a slightly higher percentage than the growth in assets under management.

Investments in private equity funds have been channeled both into Mexico (56% at market value as of June 2024) and internationally (44%). Regarding investments in Mexico, according to information published by Dario Celis (El Heraldo de México on July 31), the AFOREs invested $805 million in 12 combined cycle plants and a wind farm that the government purchased from the Spanish company Iberdrola. This investment is close to the average growth rate over the past six years (0.22% investment in Iberdrola vs. 0.28% average growth over six years), representing a significant amount invested in Mexico.

The market value of all alternative investments made in Mexico and internationally is $30.207 billion, according to public information from the 343 CKDs (133) and CERPIs (210) as of June 2024. Investments in Mexico made through CKDs represent 56%, while 44% is predominantly international since CERPIs invest at least 10% in Mexico.

The appetite for alternative investments by AFOREs is expected to increase as assets under management grow, and the percentage they represent is likely to approach the 9-10% range, which seems to be the level where AFOREs feel most comfortable.

Tikehau Capital Completes the Sale of Its Stake in Preligens to Safran

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Tikehau Capital has completed the sale of its stake in Preligens, a global artificial intelligence (AI) firm specializing in the aerospace and defense sector, to Safran for an enterprise value of €220 million. Following an exclusive negotiation process that began in June 2024, Tikehau Capital is divesting its stake in Preligens to Safran.

According to the asset manager, Preligens, founded in 2016 by two French engineers, offers field-tested AI analysis solutions for high-end imagery, full-motion video, and acoustic signals. “Tikehau Capital’s investment in November 2020 has been pivotal in accelerating Preligens’ growth, which has seen its revenues increase tenfold (from €3 million to nearly €30 million), expanded its operations in the U.S. and Asia, and now employs around 250 people, including 140 R&D engineers,” they noted.

This sale marks the first divestment of Brienne III, the Group’s first private equity fund dedicated to cybersecurity. According to the asset manager, this strategy has raised nearly €4001 million across its two funds and has now invested €150 million in 16 companies, including Trustpair, Chapsvision, and Egerie in France, and VMRay in Germany.

U.S. Equities don’t Have a Performance Problem, They Have an Expectation Problem

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The second-quarter earnings season in the U.S. is coming to an end. So far, results have surprised to the upside, with earnings per share (EPS) growth of 8% year-over-year, exceeding market estimates by 4%. A noteworthy aspect of this season is the broader participation in earnings growth, as the EPS of the S&P 500 has shown an increase even when excluding the large tech companies (Mag-7) for the first time in five quarters, notes Felipe de Solminihac, Investment Analyst at Fynsa.

In terms of sector performance, the highest earnings growth continues to be seen in technology-related sectors. In fact, the earnings growth of the Mag-7 has been 26% year-over-year.

Solminihac explains that despite the strong growth shown by the Mag-7 companies this quarter and exceeding market expectations by 6% (vs. +11% on average over the last four quarters), this has not been rewarded by investors, as the prices of all the stocks—except Meta—fell by an average of 8% in the three days following the earnings reports. In other words, when you have a sector with such high valuations in historical terms and so much implicit earnings growth, it is not enough to simply beat the current quarter’s estimates; it must exceed what had been surprising in previous quarters and also offer a strong forward-looking guidance.

For the Fynsa analyst, another risk factor is that the proportion of companies exceeding sales estimates has significantly decreased across the S&P 500. This factor could put pressure on margins in the second half of the year, as slower revenue growth combined with persistent costs could affect the future profitability of companies.

“With this background, and already thinking more about 2025, one might wonder if the market’s expected earnings growth of +15% might be a bit optimistic, especially in the context of a clearly slowing U.S. economy and valuations that are at the higher end of their historical range (Today, the market trades at 21.5 times forward P/E, representing a 23% premium compared to its historical average),” says Felipe de Solminihac.

For this reason, the bar by which corporate earnings in the U.S. should be measured is different from when the market was trading at lower valuations and prior to the AI boom.

Finally, the expert observes a crucial differentiation within the equity market: the S&P 500 equal weight trades at a 20% discount compared to its market cap-weighted version. This differentiation could present a better way to gain exposure to the U.S. market.

Industry Professionals Expect the SEC to Be More Flexible With Digital Assets

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SEC fines J.P. Morgan subsidiaries

Institutional investors and wealth managers expect more flexible regulation from the U.S. Securities and Exchange Commission (SEC) in the coming year regarding digital assets, along with greater clarity, according to a new global study conducted by Nickel Digital Asset Management (Nickel), a London-based, leading regulated and award-winning digital asset hedge fund manager in Europe, founded by former alumni of Bankers Trust, Goldman Sachs, and JPMorgan.

The study, conducted with organizations already investing in the sector, found that 68% expect greater flexibility from the SEC compared to 35% who anticipate stricter regulation. More than half (53%) expect increased clarity and guidance, while 44% believe the regulator will be more constructive, reflecting political changes.

Nickel’s research, which surveyed institutional investors and wealth managers in the U.S., U.K., Germany, Switzerland, Singapore, Brazil, and the United Arab Emirates, who collectively manage around $1.7 trillion in assets, found strong support for the SEC and recognition of its importance in the sector.

Around 90% believe the SEC has been an effective regulator of the digital assets sector, and 85% say it is currently very or somewhat favorable to the sector. Only 5% say it is either not constructive or aggressively restrictive. Approximately four out of five (80%) believe it has been clear in distinguishing between securities and non-securities in the digital assets space.

Nearly three out of four (73%) say the SEC’s recent clarifications on Security Token Offerings (STOs) have had the most significant impact on the sector, compared to 42% who highlight its guidelines for Initial Coin Offerings (ICOs).

Around four out of five (80%) agree that SEC regulatory clarity is important for the sector, and 83% say the SEC’s regulatory actions will have a very or somewhat positive impact on innovation in the digital assets space.

However, only 35% of respondents say SEC regulations have a significant impact on their investment decisions in the digital assets sector, while 55% say the regulations have a moderate impact, and 10% say they have a slight impact.

“Strict regulatory actions against FTX and Binance have contributed to increasing confidence in the digital assets sector. The survey reveals that institutional investors and wealth managers now expect more flexible regulation of the sector by the SEC after a period of intense scrutiny. It is reasonable to assume that a more accommodative regulatory environment will drive growth of the asset class in the U.S.,” comments Anatoly Crachilov, CEO and founding partner of Nickel Digital, in light of the survey results.

Muzinich & Co. Strengthens Its Presence in US Offshore With Jesús Belascoain in Miami

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Muzinich & Co. has strengthened its presence in the US Offshore Latin American market by relocating Jesús Belascoain Gómez to Miami.

“The offshore market is one of our key targets as we seek to expand our credit solutions through a wider range of distribution channels. Jesús’s relocation, to be closer to our clients in the region, demonstrates our commitment to this channel as we continue to develop and promote our ability to create solutions based on our clients’ risk/reward parameters,” said Rafael Ximénez de Embún, Country Manager for Iberia and LatAm at the firm.

Belascoain, who has 20 years of experience in financial services, joined Muzinich in 2015.

At Muzinich’s Madrid office, Belascoain was responsible for the business development of the company’s wholesale and institutional client base in Spain, Portugal, and Latin America.

“Muzinich is already recognized as a respected corporate credit manager in the region, with a diverse offering that covers the entire credit spectrum. In this new challenge, I am looking forward to continuing to work on established relationships and creating new ones that highlight the firm’s longevity, expertise, and range of credit products in both public and private markets,” commented the industry veteran who arrived in Miami.

According to BrokerCheck, Belascoain obtained his FINRA licenses in July of this year.

August Has Passed… and the Market Is Once Again Suffering From Excesses

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The correction in the S&P 500’s price at the beginning of August was resolved almost as quickly as it occurred, and the market is once again suffering from the same symptoms of overvaluation and technical and sentiment-driven excesses.

The market is nearing overbought territory again, and retail investor surveys are once more showing excessive confidence, as evidenced by investors’ reaction to Nvidia’s results on Wednesday, with a post-market drop that reached 7%.

The numbers highlighted the potential of the business: the company continues to exceed consensus expectations in sales, margins, and EPS quarter after quarter. Its outlook for medium-term demand maintained the optimism of previous quarters. “We expect to grow our data center business significantly next year. Blackwell is going to completely change the game for the industry,” said Jensen Huang, CEO of Nvidia. Additionally, concerns about delays in the launch of its new product, Blackwell, were alleviated. However, the strong performance and the CEO’s comments—unclear regarding the ROI impact of the massive GPU investments by companies like Microsoft, Google, Amazon, or Meta—did not fully satisfy investors’ optimism.

This is relevant because Nvidia is one of those rare cases where a single company, or sometimes a single industry, like technology in 1999, becomes so significant that it comes to dominate the macroeconomic landscape by embodying the essence of the generative AI theme. This is the underlying idea behind the stock market rally over the last two years, since the official launch of ChatGPT in November 2022.

The numbers don’t lie: this year, the GPU company contributed about 230 points to the S&P 500 before the earnings release, accounting for 27% of the total returns the U.S. index has generated so far this year.

Maintaining business momentum like the one Nvidia has shown over the past 12 months is not sustainable, and its growth is slowing both year-over-year and quarter-over-quarter—although, to be clear, sequential growth is expected to pick up again in the fourth quarter as Blackwell begins reaching end customers, while demand for Hopper remains strong.

At a macro level, a similar situation is unfolding, despite the desire to celebrate Jerome Powell’s comments at Jackson Hole a few weeks ago. Despite the strong U.S. GDP data for the second quarter and the July retail sales figures, there is evidence of weaker growth. Manufacturing activity has contracted again, and the U.S. consumer, the main driver of global expansion over the past two years, is now less dynamic.

Real disposable income is growing at only 0.9% year-over-year, and a number of multinationals tied to household spending disappointed during earnings season (e.g., McDonald’s, Ford, Alphabet, or LVMH). The excess savings accumulated during the pandemic have been spent, fiscal policy will be less generous—regardless of who ends up in the White House in 2025, and especially if it’s Donald Trump—and the labor market is showing signs of fatigue.

Cumulative unemployment claims suggest that companies are reluctant to hire, and while the most optimistic observers attribute the activation of the Sahm rule to the exceptional nature of Tropical Storm Beryl, which impacted the U.S. Gulf Coast in July, the rise in unemployment over the past 12 months is affecting not just Texas but 80% of the 51 states that make up the union.

While it is true that payroll growth continues to be positive—and is usually negative in the context of economic contractions—this fact confirms that immigration is likely the main cause of the rise in unemployment from a low of 3.4% to 4.3%. We find ourselves in the unusual situation of rising unemployment alongside a growing economy because the imbalance is coming from the supply side of workers.

Demand is moderating, as indicated by the JOLT (Job Openings and Labor Turnover Survey) data on voluntary quits and hires. Although the economy is still creating a reasonable number of jobs each month, and inflation-adjusted private sector wages are increasing by 2.5%, these figures do not pose an imminent threat to GDP. However, growth has peaked, is deflating, and raises doubts about the ability to meet the ambitious EPS growth projections that consensus is forecasting for 2025.

On the geopolitical front, the potential implications of Harris overtaking Trump in betting markets (according to PredictIt, but not Polymarket) and in polls do not appear to be adequately priced into stocks. Investors don’t like the economic platform of either candidate, but in Harris’s case, it is assumed that Republicans will control the House of Representatives or the Senate (if not both), which would prevent much of her fiscal agenda from coming to fruition. In Trump’s case, he would have near-unilateral authority on tariffs, creating risk regardless of what happens with Congress.

Financial Advisors Will Lean Even More Towards ETFs in the Coming Years

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Advisors are increasing allocations to ETFs as they become more comfortable with the product and its use across a broader range of asset classes, according to the latest edition of The Cerulli Edge-U.S. Monthly Product Trends.

According to the study, which analyzes ETF flows up to July 2024, nearly all advisors (90%) use the product in some way.

On the other hand, while active managers can add value, 61% of advisors agree or strongly agree that it is difficult to identify active managers who consistently outperform the indices.

Hybrid RIAs advisors allocate the highest percentage of assets to actively managed ETFs across all channels, and numerous asset managers are dedicating resources to expanding their product range to include more active ETFs.

In July, mutual fund assets grew by $332 billion (1.7%) over $39.5 billion in total net outflows, representing an organic growth rate of -0.2%.

Total asset growth for 2024 is $1.6 trillion, despite total net outflows of $175 billion.

Additionally, during July, ETF assets grew by $329 billion (3.6%), with $119 billion attributed to net inflows, marking their second strongest month in history.

In 2024, ETFs assets have increased by $1.4 trillion (16.8%), with total net flows of $526 billion, representing an organic growth rate of 6.5%, concludes the report.