This year’s ETF issue coincides with a milestone birthday for the exchange-traded fund SPY). From that single product has grown an industry with $1.44 trillion currently in assets.industry. In 1993, the first exchange-traded fund launched, the SPDR S&P 500 ETF (
Even with the popularity and widespread use, ETFs and exchange-traded notesare not completely understood. A new survey from Cerulli Associates asked advisers to rank their knowledge of ETF-related topics. ETF liquidity and trading ranked as the characteristics that advisers said they were the least knowledgeable about.
This is not surprising since a sizeable portion of ETF trading occurs not on the secondary market, where you and I trade, but in the primary market. Institutional traders, hedge funds and high-frequency traders can exchange a large block of ETF shares (typically 50,000 shares) with a fund’s sponsor for a basket of the underlying securities. The same investor can also put together a basket of the underlying shares and trade for a block of ETF shares, known as creation units. Once this transaction is completed, the institutional investor can then trade small blocks of the ETF’s shares on the open market, where you see the transactions appear in the day’s trading volume.
This practice, known in the industry as in-kind redemption, allows for a certain level of arbitrage to occur. If an ETF composed of frequently traded securities is priced differently from the value of its underlying portfolio, a firm can step in and use the in-kind redemption process to take advantage of the arbitrage opportunity. This entire process is possible not only because of in-kind redemptions, but also because of the transparency of ETF portfolios.
Neil Leeson of Ned Davis Research sheds more light on the construction of ETFs. In a comprehensive article, he explains how to truly judge the liquidity of an ETF, why ETFs are often more tax-efficient than mutual funds and the implications of tracking error for your portfolio. He also brings attention to an expense you may not even know to look for: the fee waiver. His article starts here.
If you like Neil’s article or just want to learn more, come to the AAII Investor Conference this November in Orlando. Neil will give a presentation on ETFs. You will also get to see several other great speakers, including keynoters Robert Shiller and James O’Shaughnessy. More information about the conference can be found here.
This month’s feature is our annual ETF guide. You will find 437 funds in the print version and a comprehensive spreadsheet with all 1,479 ETFs on AAII.com. As in previous years, we’ve included data on performance (including bull and bear market returns), expense ratios, turnover ratios, net asset values and portfolio construction. The guide starts here.
New in this year’s guide is a listing of the 15 largest ETFs. Despite the existence of so many ETFs and ETNs, more than a third of all assets are managed by just 15 ETFs. The five largest ETFs control more than $2 out of every $10 in ETF assets. The largest fund, SPDR S&P 500, single-handedly manages 9.2% of all ETF assets. Put another way, SPDR S&P 500 has $133.3 billion in assets under management; the median AUM for all ETFs is $64.6 million.
In addition to the ETF milestone, this issue marks another birthday: our Model Fund Portfolio is now 10 years old. AAII members who have followed the portfolio since its inception have done well, with an 8.6% annualized return versus 7.2% for the S&P 500. The key to mimicking the performance is to follow the additions and deletions. The latest change is the addition of a frontier markets ETF. As Jim explains here, the change is being made because the new addition offers more potential upside than the small-cap dividend fund previously held in the portfolio.
Wishing you prosperity,
Charles Rotblut, CFA
Editor, AAII Journal