What is an ETF and how does it work?

Last week I wrote about Generation Z and investing. In that piece, I also cited the growth of then Exchange Traded Fund (ETF) and how this investment vehicle with it's access and low cost is really important in the helping new and existing generations access and take part in investing.

A little history

As luck would have it, this week marks the 30th Anniversary of the S&P 500 Trust with the ticker SPDR, affectionately known as spider (hence the picture in the article).

What's probably less commonly known is that the investment vehicle now known as the ETF, was conceived by working to understand and prevent what happened during the Market Crash of 1987, known as Black Monday.

Or at least this was how it was adopted.

Created actually in Canada on the back of Nate Most's work observing how commodity traders, mostly in Asia, bought and sold receipts of Gold, Oil or other commodities, rather than lugging them around for physical trade.

It took some 3 years with the regulators and was seeded with $6.5 million, it launched in 1993.

Fast forward to today and spider has around $300 to $400 billion of the c$10 trillion ETF market.

All based on that principle of a product that could trade a 'basket' of assets (in the case of SPDR, the S&P 500 index of stocks) within a single vehicle.

Basket Bonanza

Since those beginnings, the world of ETF's has grown exponentially and exploded in variety and choice.

Just look today and you can buy any one of a range of thematic (hold the shares of companies in a specific sector or genre) ETFs from the Metaverse to the amazingly named TANN, which tracks a bucket of firms attached to the generation of solar energy, and even onto ETFs built to short (to bet against) whatever famous CNBC presenter Jim Cramer says you should be investing in. The 'Reverse Cramer' is it's name and yes, it has buyers - lots of them.

More mainstream and sensibly perhaps, ETFs have become the staple of many adviser, wealth manager and even gargantuan asset managers holdings with exposure to certain indices or baskets at a low cost and unrivalled liquidity.

How are they used?

They're used in a number of ways.

They can be a single holding for a DIY investor that just wants to buy the market, say the US S&P 500 (largest 500 US companies by market share) and hold until they retire.

Others may use them as a way of diversifying into areas where they carry less expertise. A US investor may use a European or International ETF to capture upside from overseas investments to diversify an otherwise purely US portfolio.

For a discretionary investment manager or wealth manager such as us, we use them in multiple ways.

Although in their purest for they are a 'passive' asset, that is, you own the bucket rather than the individual assets within the bucket. As a tactical manager, we enjoy their low cost & liquid nature and, as mentioned already, the choice available now means that we can specifically target sectors (eg Financials or Energy) and/or geographies (eg Europe or Emerging Markets) that have been identified from our research and data signals to allocate to quickly and broadly allowing us to be agile and active but at a low cost to clients.

Unstoppable ETFs

From very slow initial adoption in the US, it is expected that as soon as next year, ETFs with overtake Mutual Funds in terms of overall asset size.

This may not mean much but if you look at the chart and the growth of Mutual Funds from 1955. For ETFs to get there since 1993, is quite remarkable.

If you have any kind of money, be it a pension, an ISA or anything else that is 'managed' by anyone else, chances are you own an ETF of some kind so it's definitely worth getting to understand a little bit more about this investment product.

I hope this has helped peak some interest and if you want to learn more, here are 3 great sources for you:

1. Eric Balchunas of Bloomberg has amazing insight in ETFs and his Trillions Podcast with Joel Webber, is a must listen.
2. Allan Lane who along with Irene, are both good friends of ours and with distinguished careers at places like iShares have forgotten more about ETF and portfolio construction than the rest of us know!
3. IronMarket Wealth because, well why not?

Thanks for reading & sorry it's a day late!

Wes

#ETFs #sharedknowledge #therespowerwithin