Exchange Traded Funds (ETFs)

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A New Type of Index Fund Hybrid

[By JD Steinhilber]

ME-PExchange-traded funds (ETFs) are perhaps the most exciting and innovative investment products to be developed by the securities industry in the past 20 years. ETFs, which are essentially index funds that trade on the major exchanges, can enable the physician-investor or financial-advisor to add value to client relationships, by addressing the key issues of diversification, tax efficiency and investment costs.

Definition 

More formally, ETFs are defined as securities that combine essential elements of individual stocks and index funds. Like stocks, ETFs are traded on the major U.S. stock exchanges and can be bought and sold through any brokerage account at any time during normal trading hours.

Also like index funds, ETFs are pools of securities that seek to replicate the performance of specific market indices, or benchmarks, in a low-cost, tax-efficient manner. ETFs give physician investors the opportunity to buy or sell an interest in an entire portfolio in a single transaction.

In short, ETFs provide the advantages of traditional index mutual funds, including low annual fees, diversification and tax-efficiency, with the liquidity and ease of execution of stocks. 

ETFs trade throughout the day and allow investors to buy and sell them at stated market prices, unlike traditional open-end mutual funds, which are only bought and sold at their net asset value (NAV) determined at the end of each day. ETFs can also be bought on margin and sold short. 

ETFs were developed by large institutions, such as: Barclays Global Investors, State Street Global Advisors and Vanguard.In 2003, approximately $90 billion was invested in U.S. exchange-traded funds; that figure has more than doubled by 2008. 

ETF Asset Classes

ETFs provide exposure to a wide range of asset classes defined by various equity and fixed income indexes. At launch, available ETFs fell into multiple major categories, including:

  • Small-, mid- and large-capitalization
  • Growth, value and core
  • International (broad-based and country- or region-specific)
  • U.S. industry sectors
  • Fixed income

Of course, there are many more tranches or slices today, and for almost any asset class type imaginable. The indexes upon which ETFs are based are from Dow Jones & Company, Inc., Frank Russell Company, Goldman, Sachs & Co., Lehman Brothers, Morgan Stanley Capital International (MSCI), Standard and Poor’s, Cohen & Steers Capital Management, Inc. and the NASDAQ Stock Market, Inc; etc; among many others asset class benchmarks.

Sponsors and Types

The two principal initial sponsors of sector ETFs were State Street Global Advisors and Barclays Global Investors. State Street’s sector ETFs are termed Sector SPDRs (Standard & Poor’s Depositary Receipt), because they are based on the S&P 500. 

The nine original Sector SPDRs collectively encompassed all 500 companies of the S&P 500. Barclays’ iShares sector funds differ from the Sector SPDRs in that they are based on the Dow Jones classification system, which segments the U.S. economy and stock market into 10 sectors encompassing 1,625 companies.

There were iShares ETFs for each of these 10 sectors as well as certain industries, such as biotechnology which are components of broader and/or narrower sectors.  Today, they are almost TNTC.

Assessment 

Continuous information about sector and industry ETFs is available at www.ishares.com.  Information about Sector SPDR ETFs is available at www.spdrindex.com.

Conclusion

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Speaker: If you need a moderator or speaker for an upcoming event, Dr. David E. Marcinko; MBA – Publisher-in-Chief of the Medical Executive-Post – is available for seminar or speaking engagements. Contact: MarcinkoAdvisors@msn.com

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10 Responses

  1. Here is another link, on ETFs, from the WSJ with a nice historical review:

    http://online.wsj.com/article/SB119930962346763093.html?mod=%28_pageid_%29_leftbox

    PS: Congratulations for being syndicated and picked up by the Wall Street Journal.

    Like

  2. Lessons Learned In The Exchange-Traded Fund Graveyard

    While ETF closures can be an inconvenience for investors in the short-term, in the long run they are healthy for the industry and investors.

    http://www.fa-mag.com/news/lessons-learned-in-the-exchange-traded-fund-graveyard-15682.html?section=108

    Ed

    Like

  3. Health Care ETFs?
    [Four Things To Consider]

    The health care industry has been one of the fastest growing segments in the market. But, what is the appeal?

    http://www.fa-mag.com/news/health-care-etfs–four-things-to-consider-15881.html

    The Hidden Costs of ETF Investing

    And, although ETFs are generally cheaper than mutual funds, physician investors shouldn’t ignore the fees associated with these vehicles.

    http://www.fa-mag.com/news/the-hidden-costs-of-etf-investing-15787.html?section=108

    Dr. Lee

    Like

  4. Got a great investing idea?
    [Start your own ETF]

    A new online broker allows you to create theme-based baskets of stocks.

    http://money.msn.com/exchange-traded-fund/got-a-great-investing-idea-start-your-own-etf

    And, if other users like your idea enough to buy into it, you’ll receive royalties.

    Ed

    Like

  5. Bill Gross leaves PIMCO for Janus

    Did you know that Bill Gross, one of the bond market’s most renowned investors, is leaving PIMCO, the investment firm he founded and with which his name has been effectively synonymous, for rival asset management firm Janus Capital Group? .

    http://money.msn.com/business-news/article.aspx?feed=OBR&date=20140926&id=17965084

    Was there an ETF scandal over there?

    Jennie

    Like

  6. The investor return/behavior gap

    I am often bewildered that what passes for analysis is really a focus on recent performance, rather than process. Yet, so little attention is given to the investor return/behavior gap, a well-documented phenomenon that proves that “on, average, investors sacrifice a substantial portion of their returns by incorrectly timing when to enter or exit investments”.

    (https://blogs.cfainstitute.org/investor/2015/07/27/how-financial-advisers-can-help-close-the-behavior-gap/).

    Incorrect timing tends to come from chasing performance, getting in after a major up move has already taken place, and then, of course, exiting when the drawdown is likely near its end. The below chart sums up some of the research on this which, in my opinion, is a “must know” when considering where to put money to work.

    The best returns in the future come from those parts of the marketplace that have not done well in the past. Yet despite the overwhelming evidence which supports this, strong recent performance is often the core catalyst to make an investment. In reality, it should be the exact opposite.

    High past performance and continuous visibility of that performance is a temptation too strong for many to ignore, and that temptation unequivocally results in sub-optimal returns going forward on average. Take that truism on mutual funds, and magnify it by a billion when it comes to Exchange Traded Funds (ETFs). Yes folks – I would argue to you that ETFs are the greatest danger to investors. Why? Because ETFs provide an even greater temptation to chase recent performance, day by day, hour by hour, and minute by minute. Overtrading is the ultimate source of the investor return gap, and the temptation to get “in and out” of the market has never been higher thanks to these investment vehicles.

    Now, don’t get me wrong here. We ourselves use ETFs to execute across our quantitative strategies in mutual funds and sub-advised separate account strategies we run. However, following a systematic, backtested, and quantitative approach using ETFs as the vehicle of choice for execution is NOT what the vast majority of ETFs “investors” do. The pattern of behavior remains the same. Assets for ETFs grow when the ETF has strong recent performance, and collapse after, with a lag, when losses have already occurred. In our case, we rotate based on leading indicators of volatility (click here to learn more). The majority rotate based on old leaders that have had continuously low volatility.

    The greatest danger is in using past strong performance to make an investment decision. ETFs may be the greatest temptation of all that results in exactly that.

    Michael A. Gayed CFA
    [Portfolio Manager]

    Like

  7. 5 common misconceptions I had about ETFs

    After my first summer internship, my dad urged me to open a Roth IRA and start saving for my retirement. The Roth IRA was a relatively new invention as of the Taxpayer Relief Act of 1997, but my dad was always on top of these financial matters, so he helped me open a Vanguard Brokerage Account.

    It was the dot-com boom and I dutifully invested my hard-earned $1,500 dollars into JDS Uniphase, only to watch it drop 20% within a few months when the market went to pieces. The dot-com boom-and-bust taught me one valuable lesson—stick with index funds, pal.

    I love the idea of index funds—they invest in all the companies in an index, such as the S&P 500. You don’t have to pick the right company because when you invest in a single fund, you’re essentially picking them all.

    As a young person, mutual funds fascinated me. What could be better than buying shares of a mutual fund and pooling my money with other investors who want their money invested in accordance with a specific investment strategy? And, at the time, they were the only type of fund that could track an index.

    Mutual funds are great, but you can only buy and sell after the market closes. Getting a price update on a fund only once a day seemed a little slow. Archaic, even.

    When I heard about ETFs, which are priced throughout the day, I thought they were a new investment. In reality, the first ETF in the United States was launched in 1993—25 years ago!

    Thinking of ETFs as a “new” investment was the first of many misconceptions I’ve had to unlearn!

    What are ETFs?

    If you know about mutual funds, then an ETF will be familiar. ETF stands for exchange-traded fund. It’s similar to a mutual fund except it’s traded on an exchange like a stock. Since you can buy and sell shares throughout the day, which you can’t do with mutual funds, you can see the real-time price of the ETF anytime.

    ETFs and mutual funds are similar in many ways. Just as there are index mutual funds, there are index ETFs. Index funds—both mutual funds and ETFs—are passively managed funds that seek to match the performance of an underlying index. An S&P 500 index fund tries to match the performance of the S&P 500 Index and it’s one of my favorite passive income investments.

    The biggest difference between mutual funds and ETFs is how often shares are priced. Mutual funds aren’t traded throughout the day on the open market. When you “trade” shares in a mutual fund, the transaction happens only once a day after the markets have closed. You can trade ETFs on the open market throughout the day, so you always know the exact price of a share.

    There are many misconceptions about ETFs—I know because I believed a lot of them, and today we’ll dispel some of the biggest.

    1. ETFs are more volatile

    I’m a firm believer that you should buy and hold stock investments for the long term. A mutual fund, especially a low-cost index fund that only transacts once a day, feels stable.

    Why would I want an ETF that has its shares bought and sold all day? I don’t want to watch the price change by the minute.

    An ETF is just a fund that holds a basket of stocks and bonds that move up and down throughout the day. A mutual fund does the same thing. The only difference with a mutual fund is that you only see price changes once a day after the market has closed. The value of the mutual fund’s shares change throughout the day, as its investment holdings’ values change—you just don’t see it.

    An ETF isn’t inherently more volatile just because you can trade it. It only feels that way because you see the price in real time. An ETF’s volatility is based on the securities it holds—if it tracks the same benchmark as a mutual fund, the volatility will be comparable.

    2. ETFs are “copies” of mutual funds

    I thought all ETFs were exchange-traded versions of an existing mutual fund. For the first two decades, this was mostly true. ETFs were all based on existing benchmark indexes like the S&P 500 and Russell 2000.

    Most ETFs are index funds, but you can get ETFs with a wide variety of investment strategies. There are ETF versions of your favorite index funds, like the S&P 500, as well as bond and stock funds. You can buy ETFs by asset type or sector, like a health care ETF that seeks to match the performance of the broad industry.

    3. ETFs are more expensive

    Buying and selling ETFs can be more expensive because they’re bought and sold like stocks. Each transaction is subject to a commission, which is a fee you may have to pay your broker.

    However, many brokers that offer ETFs let you buy and sell some ETFs without paying a commission. When a brokerage offers commission-free ETFs, it levels the playing field with mutual funds and makes ETFs at least as affordable (if not more so) as mutual funds.

    Commissions aside, when it comes down to it, an ETF is like any other financial product—price varies. An ETF isn’t inherently more expensive than a mutual fund with the same investment objective that tracks the same underlying index.

    I was surprised to discover that, in many cases, an ETF may actually have a lower expense ratio than a similar mutual fund. (An expense ratio is the total percentage of fund assets used to pay for administrative, management, and other costs of running a fund.)

    4. ETFs are less tax-efficient

    ETFs are bought and sold throughout the day on an exchange, just like stocks. I thought this frequent-trading activity made them less tax-efficient.

    In reality, it doesn’t. The shares of an ETF may change hands, but the underlying assets don’t.

    When you buy and sell shares of a mutual fund, the mutual fund’s underlying assets change, and the fund must buy and sell securities to reflect this. If there’s a significant flow of money in either direction, the mutual fund buys or sells the underlying securities to account for the change.

    This activity can create a taxable event. If a mutual fund sells a security for more than its original price and realizes a net gain, you (the investor) are subject to capital gains tax, plus the taxes you may owe when the fund makes a distribution, such as a dividend payment, to your account.

    On the other hand, when you buy and sell shares of an ETF, the ETF doesn’t have to adjust its holdings, which could trigger gains and losses. While an ETF buys and sells its underlying securities as needed, outside forces don’t affect an ETF as easily as a mutual fund. This makes an ETF more efficient under the same circumstances.

    5. All index ETFs are created equal

    If you want to buy an S&P 500 ETF, you have many options.

    Vanguard S&P 500 ETF (VOO), iShares Core S&P 500 ETF (IVV), and SPDR S&P 500 ETF (SPY) are all ETFs that seek to match the performance of the S&P 500 Index. They’re not all priced the same, however.

    If you review their expense ratios, you can see a big difference.

    More importantly, if you compare the year-to-date performance of each ETF, they may not match exactly. They may not even match the performance of the benchmark index, the S&P 500. This difference is known as tracking error.

    ETFs use different approaches to match what they track. With an index, most ETFs buy the stocks in the index at the proper weightings. As the components or weightings of the index change, the ETF adjusts accordingly, but not instantaneously. This may lead to a difference in the returns based on how quickly the ETF adjusts.

    You might think a positive tracking error is a good thing because the fund’s return is higher than the underlying index. A slight difference is acceptable, but you don’t want a large disparity. The goal of investing in an index fund is to mirror the returns of the underlying index given its risk profile. If the fund’s holdings no longer match its respective index, you may be exposed to a risk profile you didn’t sign up for.

    It’s important to review the ETF’s expense ratio and tracking error before selecting the ETF you want.

    Why doesn’t everyone buy ETFs?

    Does it sound like ETFs are amazingly flexible? What are the benefits of mutual funds?

    One big factor in favor of mutual funds is choice. There’s a wider selection of mutual funds because they’ve been around longer.

    And don’t forget cost, since you’ll usually pay a commission when you buy and sell ETF shares.

    I hope I’ve dispelled a few of the misconceptions you may have had about ETFs and consider them the next time you think about your portfolio.

    Jim Wang
    [Vanguard]
    via Ann Miller RN MHA

    Like

  8. 2021

    In 2013, the Winklevoss twins filed the first application for a bitcoin exchange-traded fund (ETF). Eight years and countless rejections later, the first bitcoin-based ETF could begin trading as soon as today.

    The ETF, launched by the fund manager ProShares, will give virtually any investor with a brokerage account the ability to gain exposure to the world’s largest crypto.

    We didn’t say “buy the crypto,” because that’s not what’s happening. The bitcoin ETF is based on futures contracts, which allow investors to bet on the price swings of an underlying asset without owning it outright.

    The SEC, Wall Street’s top sheriff, is much more comfortable allowing a futures-based bitcoin ETF to proceed than one that directly buys the tokens. Bitcoin futures have been trading on the regulated Chicago Mercantile Exchange since 2017. Bitcoin itself, meanwhile, is bought and sold on many different exchanges that are outside the gaze of the SEC.

    Edward

    Like

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