The author of this article tours the history of ETFs to the present day, examining the reasons for their continued popularity – and a few potential problems.
Exchange-traded funds are now a familiar part of the wealth
management toolkit, and the ETF market has boomed in past
decades. What explains their ascent, what uses do they have,
where is innovation taking place and what are the risks and
downsides to ETFs? To give a balanced assessment is Alexey
Afanassievskiy, executive director and head of portfolio
management at the European broker Mind Money.
The editors are pleased to share these views and we invite
readers to jump into the conversation. The usual disclaimers
apply to views of outside contributors. Email tom.burroughes@wealthbriefing.com
Exchange-traded funds have gained popularity among active
investors. In the last five years, the market share of active
ETFs has more than quadrupled. Active strategies have picked
up more than $370 billion in inflows. Moreover, investors feel
positive about the growth of the global ETF market. By 2028, the
global volume of the ETFs” sector could exceed $19.2 trillion in
AuM.
Is it a typical short-run hype or a wise investment strategy?
Let’s figure it out.
ETFs are almost 30 years old. How did they appear?
ETFs are actually far from a new thing; they appeared more than
30 years ago. In 1976, John Bogle, founder of The Vanguard Group,
created the first index fund. His idea was to accurately
replicate the structure of an exchange index and sell it as a
separate asset, charging much lower commissions.
In 1990, the first ETF appeared, replicating a portfolio of
shares from the Canadian index, and in 1993, the very “spider”
ETF (SPDR), which repeated the S&P index, was created. Thus,
the ETF is not an emerging phenomenon; it has been around in the
financial world for more than 30 years.
At first, ETFs were limited only to index duplicating. There was
a convenient way to collect a basket of stocks that correlated
with the index. Later, other tradable funds appeared, which
wrapped other assets, such as physical gold and even full-fledged
trading strategies. The first feature of an ETF was the ability
not to collect a portfolio of shares yourself or not to buy
physical gold but simply to buy a security paper.
Benefits of ETFs: confidence and
safety
Firstly, the ETF has a clearly defined algorithm. Unlike
management companies, investors know exactly what results to
expect. At the same time, the volumes in ETFs are usually very
large, and the maintenance costs are insignificant. Some of the
ETFs have low fees, even for complex ETFs that implement
non-trivial strategies, coming out directly from the returns.
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Additionally, an ETF is technically considered a security. For
instance, if you invest in futures and encounter issues with a
broker, exchange, or other intermediaries, there’s a high
probability of losing your investment. In the case of an ETF,
these are securities that are in your account, and, in the
absence of fraud on the part of the broker, they are much better
protected than classic derivatives.
ETFs now encompass a wide range of strategies. Buyers can choose
funds for their portfolios based on various market views.
However, unlike hedge funds, which are often flexible in managing
client assets, ETFs are bound to adhere strictly to their
prospectus and stated approach. This doesn’t guarantee higher or
lower returns, but it does ensure confidence in market actions.
Beyond low commissions and security, the synergy between index
ETFs and futures advances their utility in active strategies. For
instance, selling short positions using sold index futures can be
profitable since their prices are higher, excluding interest
rates and dividends. Statistics show that demand for active ETFs
is rising – nearly 80 per cent per cent of ETF investors
have purchased at least one active ETF in the past
year.
ETFs may not be as positive as they seem at first
sight
Despite a number of advantages, ETFs may also entail some
drawbacks. The biggest disadvantage is market risk, meaning that
ETFs are subject to the same market risks as the underlying
assets they track. For example, if investors buy an S&P 500
ETF and the S&P 500 goes down 50 per cent, nothing will help
them – ETFs are not a safe haven.
ETFs are sensitive to market movements, economic events, and
changes in investor sentiment. This volatility can be
particularly pronounced in ETFs that track sectors, commodities,
or emerging markets, where price swings can be more dramatic.
Additionally, during periods of extreme market stress, ETFs can
experience rapid price declines, and their liquidity can dry up,
making it challenging for investors to exit their positions at
favourable prices.
Furthermore, research shows that the benefits of buying ETFs can
be over evaluated – the approach to investment is far more
important than what to invest in. A study by UTS found that ETF
portfolios underperformed non-ETF portfolios by 2.3 per cent
annually; however, the result was explained not by the ETFs but
by the buy-and-hold strategy.
Recent changes transformed the world of ETFs.
How?
The recent introduction of the bitcoin ETF highlights a
significant trend in the evolution of exchange-traded funds.
Unlike traditional ETFs, bitcoin ETFs are a new addition,
generating considerable hype and capturing widespread attention –
nearly a quarter of investors (23 per cent) are most optimistic
about digital currency ETFs. Such innovations in ETFs are making
them more sophisticated, resembling structural products with
advanced security algorithms.
While these specialised ETFs appeal to a smaller, niche audience,
their complexity and targeted nature mean that they require
careful explanation and understanding. Both private investors and
companies should evaluate their needs and strategies, ensuring
that interest in ETFs continues to grow.
About the author
Alexey Afanassievskiy is executive director and head of
portfolio management at the European broker Mind Money. He is a
financial services professional and a C-level executive, with
more than 30 years’ experience in the stock market.