Since the launch of the first exchange traded fund in January 1993, ETFs have become one of the most popular investments for both institutional and individual investors. Promoted as cheaper, more transparent, more flexible, more liquid and more tax efficient than mutual funds, ETFs provide low-cost diversification as well as trading and arbitrage options for investors.
Twenty years after the Standard & Poor’s 500 Depository Receipt ETF (Spider for short) debuted, the number of options ETF investors have has swelled. Currently, there are 1,439 ETFs in the United States and 4,778 globally with assets totaling $12.9 billion and $2.09 trillion respectively, according to data from CNBC. And those numbers keep growing. In the first six month of 2013, 65 new ETF were launched. ETFs have become so popular that many brokerages offer free trading in a handful of them.
Indeed, the ETF is one of the most successful and explosive financial innovations in recent decades. Cheapness, convenience and profitability are the main drivers behind ETFs’ successes. The industry has expanded at such a quick clip that it’s now possible for investors and professional traders to use ETFs to invest in almost any asset class, rapidly trade in and out of them, and switch a portfolio’s allocation in mere seconds. That has made ETFs hugely attractive and popular among high frequency traders and hedge funds. In 2012, some 16% of trading volume at the New York Stock Exchange was in ETFs.
Moreover, there appears to be no slowdown in the industry’s growth. Last year, investors poured some $265 billion into ETFs, up from $170 billion in 2011. Over the last ten years, compound annual growth rate of assets in ETF funds has been a vigorous 29.6%, data from information provider ETFGI shows. Yet even with a $2 trillion+ cumulative total, the ETF industry is a mere speck when measured against the roughly $26 trillion invested in mutual funds worldwide. That leaves ETFs with lots more room for expansion and growth.
An ETF For Every Industry
There are too many ETFs to list by name and category, but these favored trading instruments run the gamut from all types of bonds to commodities to country specific to a particular industry. Many have memorable tickers like “MOO” for the Market Vectors Agribusiness ETF, “FAN” for the First Trust Global Wind Energy ETF and “WOOD” for the S&P Global Timber & Forestry ETF. And while plenty of industry professionals agree that picking a catchy symbol can go a long way toward building a fund’s presence, all concur it takes a lot more than an appealing moniker to make an ETF successful.
To be sure, even among the plethora of ETFs in the same sector, some are widely successful while others quietly, and not so quietly, flounder. According to investment banking behemoth Citigroup Inc, the seven key factors common to successful ETFs are in order of importance:
• Offers unique market access
• Offers an incentive to trade
• Builds on local market characteristics
• Has strong retail participation
• Enjoys global market participation
• Provides ease of market entry
• Has a solid market infrastructure
Stella Bray, Managing Director and Portfolio Manager at Palm Beach Gardens, FL based HighTower’s Wisehaupt Bray Asset Management, is a fan of exchange traded funds and helps runs the firm’s carefully curated ETF portfolio.
“Here at Wisehaupt, Bray Asset Management, we believe ETFs are an effective way to invest in specific sectors or a particular country or group of countries. We study the macroeconomic picture, then quantitative factors and technical analysis at a sector level and use ETFs to invest in the sweet spot of the market. Once the ETFs are purchased, covered calls are written on them to create premium income. We use passive ETFs as we do the active management ourselves. We prefer ETFs to mutual funds because of the tax efficiency and lower costs, in addition to the fact that it trades like a stock. ETFs are more tax efficient because capital gains are created only when the investor decides to sell. So, the investor has control,” Bray explained to The Suit.
Active ETFs Emerge
On the heels of solid performance and increasing interest in low-cost passive ETFs that track indexes, a new breed of ETFs have emerged: actively managed exchange traded funds. The trend started with the mega-successful launch of the Pimco Total Return Bond Fund ETF in 2012. While active ETFs presently make up a mere 1% of ETF assets, they account for 19% of assets in the 87 ETFs launched year-to-date, according to Bloomberg. And, many more are waiting for the “all clear” from the Securities and Exchange and Commission (SEC).
Active ETFs focus on investment areas where active management is deemed necessary, such as the fixed income environment. The beauty (or curse depending on the outcome) is that rather than adhering to the rules and platform of the index an ETF uses as its benchmark, managers have more wiggle room. They can trade in and out of securities at any time instead of having to wait for their benchmark index’s periodic rebalancing of portfolio stocks.
Among this year’s actively managed ETF standouts are:
• SPDR Blackstone GSO Senior Loan ETF which has an investment focus on senior loans that offer high yields along with floating rates.
• Cambria Shareholder Yield ETF which measure how much money a company returns to shareholders not simply based on dividends, but also stock buybacks and debt pay downs.
• Pimco Foreign Currency Strategy ETF is an actively managed currency ETF with full discretion over its holdings and weighting, but it does has a 20% cap for any one currency.
• AdvisorShares Athena International Bear ETF is the first active ETF that scours the globe looking for opportunities to short (bet against).
• First Trust Preferred Securities and Income Fund is an actively managed fund always on the prowl for yield.
Experts say the best strategy for most investors when it comes to ETFs is to keep things simple and steer clear of the new complicated ETFs. Choose those that track a broad market index, boast the best performance and have the lowest fees. A solid ETF portfolio, industry experts maintain, can be assembled with as little as five ETFs.
Source: The Digerati Life
