by Jesse Anderson, CFA
Exchange Traded Funds, more commonly known as ETFs, celebrated their 20th birthday on January 29, 2013. SPY, an ETF that tracks the S&P 500, was introduced to the market on January 29, 1993. Today, the ETF industry is booming with thousands of different funds and over $2 trillion in assets.
For many investors, ETFs are another financial product they know very little about. These funds hold a basket of securities like mutual funds. However, this is where many of the similarities end. Unlike open ended mutual funds, ETFs trade on exchanges as their name implies. This means they can be bought and sold throughout the day. While most mutual funds are actively managed with portfolio managers trying to pick stocks that will outperform the market, most ETFs are passively managed and track an index. This also results in significantly lower expense ratios for ETFs over mutual funds. Finally, because of a redemption feature, ETFs are much more tax efficient than mutual funds. They are unlikely to have the taxable short and long-term gain distributions many mutual funds experience at the end of each year.
The first exchange traded fund, SPDR S&P 500 ETF (SPY), started tracking one of the most well know stock market indexes in the world. Initially, SPY had $6.5 million in assets. These days SPY is the world’s largest ETF with over $123 billion in assets. The ETF market expansion has also allowed investors to find a fund for nearly every asset class or geographic location. There are funds that track commodities, real estate, industries, sectors, individual countries as well as larger geographic regions.
Not all ETFs are created equal. First, investors should recognize there may be multiple ETFs tracking the same index like the S&P 500. Some of these funds may have higher expense ratios than others. The structure has also allowed firms to create more “exotic” ETFs that can use leverage and short stock. In most cases, these securities may not be suitable for the long-term investor. Also, companies have started introducing actively managed ETFs. As with actively managed mutual funds, at Snider Advisors we don’t believe any fund managers can consistently pick stocks and time the market.
The ETF boom has given retail investors a great opportunity to invest in markets and asset classes that were nearly impossible to access in the past. The exchange traded feature also creates the ability to trade options on many of the ETFs. As proponents of strategic, risk-managed options strategies, we’ve been able to create the SIM ETF Portfolio to take advantage of the many beneficial features of ETFs. You can learn more about ETFs and the Snider Method here.