Exchange-traded funds (ETFs) have really grown in popularity over the years. The first ETF was created by a subsidiary of State Street Bank in 1993 and began trading with just $6.5 million in assets. Over the past two decades the market place for exchange traded products has seen massive growth and now includes more than 1,600 different funds with over $2 trillion in assets.
ETFs are frequently referred to as a hybrid between individual stocks and mutual funds. They are similar to mutual funds in that they are an investment vehicle that typically tracks an index or a certain market segment and holds a collection of different securities. Unlike a mutual fund, ETFs trade intraday similar to the shares of an individual company (i.e. Apple or McDonalds). The price of an ETF fluctuates with the market throughout the day and you can buy or sell an ETF whenever the market is open through a regular brokerage account. Mutual funds on the other hand are priced once per day after market close and are offered to investors to buy or sell at one single price which is referred to as the net asset value, or NAV.
Another significant benefit of ETFs is that they offer greater tax efficiency than mutual funds because they are created and redeemed in a different manner. Because shares in an ETF can be created by delivering the underlying securities to a fund sponsor, the chance of unwanted capital gains distributions is diminished.
While an ETF can be either passively or actively managed, the vast majority are passive index funds. When we say “actively” managed, we are referring to a fund manager who selects individual holdings in the fund with the intent of trying to beat a related index. Because of this passive management and broad diversified exposure ETFs typically have very low expense ratios. This aligns well the investment philosophy of APCM which seeks to minimize the fees and expenses paid by our clients.
As assets in the ETF industry have grown, so too has the amount and complexity of the products available. APCM continually researches trends in the ETF industry and conducts a comprehensive annual review that looks at all of the funds our clients currently hold and compares them to other offerings in the market. We use a combination of in-house research as well as data provided by an independent evaluator to ensure our funds are liquid and provide the correct exposure to each asset class. We also look at new methodologies for asset class exposure and are currently evaluating several “smart beta” or non-market cap weighted products.
Clients often ask us to explain the characteristics of ETFs and how they work. SPDR University has great materials about ETFs and I have attached some of their materials below. As always, I am happy to send more information your way if you desire more technical details about exchange-traded funds.
Kim Butler, CFP®
Associate Financial Planner