The Strategist

What’s the secret of ETF popularity?

10/24/2018 - 14:52

There is a real boom in the exchange-traded funds (ETFs) market in the world. Their number exceeded 3,500, having increased sevenfold over the past 10 years, and the value of their net assets reached $ 4.7 trillion. What’s so interesting in there?

In recent years, there has been a real ETF boom in the world. The number of exchange-traded funds exceeded 3,500, having increased sevenfold over the past 10 years. At the end of 2017, the net asset value of ETFs reached $ 4.7 trillion. More than 70% of all investment funds accounted for the USA, 16% - for Europe, another 9% - for Asia. The influx of funds into the ETF has been going on for 55 months in a row largely due to the structure of the assets of the funds and the dynamics of the indices on the stock exchanges. For example, the US market over the past five years has grown by 70% (if you focus on the S&P 500 broad market index), with a number of sectors showing even more impressive growth. Against this background, investing in stock market indices through ETFs has become a popular strategy among private investors.

But the buzz around the ETF is not only about the growth of the market. First, it is a tool with high liquidity. This is a significant advantage of ETF over other forms of collective investment, such as US mutual funds, which have lost their popularity in recent years due to inconveniences for the investor. At the same time, the process of applying for creation or redemption of equity units that cannot be quickly bought and sold on the exchange is extremely inconvenient, often requires personal presence in the agent’s office and takes a lot of time. ETF shares, on the contrary, can be bought and sold in a few seconds - just like other stocks on the exchange. If, for some reason, exchange-traded securities are low-liquid, the situation is corrected by market makers, whose presence removes a number of other problems, including the danger of price manipulation.

The second advantage of the ETF is that it is possible to assemble a portfolio for virtually any task and with minimal transaction costs. For example, an investor who would like to independently repeat the structure of the S&P 500 index in his portfolio would require a huge amount of funds and, subsequently, additional efforts to rebalance investments. Instead, you can buy shares of one fund by paying a commission only once, and you can be sure that the portfolio structure is always kept up to date. Transaction fees with ETFs do not differ from commissions for transactions in stocks and bonds, and the management fee for such a fund is lower than that of mutual funds — on average it is 0.2% on the world market, while mutual funds and hedge funds take 1-3%.

There is an opinion that ETF has certain disadvantages compared to active money management. Critics point out that index investment, as a rule, is designed for averaging returns, therefore, it is impossible to overtake the market when investing in exchange-traded funds. Indeed, a significant number of ETFs are portfolios, repeating the structure of various stock indexes, both leading and industry. But at the same time there are a lot of funds, which are based on complex structures of various derivatives, which are often not available to a private investor. The risk of trading with such an ETF is twice as high as with a “regular” fund, but the profit is twice as high if the investor guessed the price.