The Future and Past of Exchange Traded Funds

The Exchange Traded Fund (ETF) was first introduced in Canada in 1990. The product was initially a sophisticated investment tool used by asset managers, but it has morphed into a product that retail investors have used over time. The first U.S. listed ETF was launched in 1993 on the American Stock Exchange. The SPDRs (SPY) ETF continues to enjoy widespread success. ETFs initially focused on stock trading strategies, but over time they have changed to incorporate stock sectors, commodities, currencies, and cryptocurrencies. The industry continues to add ETF methods and ETFs continue to evolve using various product structures to enhance trading strategies. ETFs have become so popular that CFD trading now tracks their movements.

What is the Structure of an ETF?

The traditional ETF is either a unit investment trust or an open-end fund. An open-end fund is a pool of invested capital that can issue unlimited shares. Dividends that are distributed from shares that the fund owns are reinvested. The fund can sell shares directly to investors and withdraw or redeem them. Shares in an open-end fund have a net asset value that provides the ETF price. Unit investment trusts are different in that they do not reinvest their dividend and instead hold them and distribute them to their investors quarterly or annually.

How Have ETFs Changed?

The initial ETFs that were introduced tracked the movements of stock indices. As mentioned, the first U.S. ETF was the SPDRs (SPY) S&P Investment Trust. This ETF tracks the trends of the S&P 500 index. Following the introduction of the SPY, the QQQ Investco Trust Nasdaq and the SPDR Dow Jones Industrial Average were brought to market. Initially, ETFs tracked the movements of large indices but changed over time to follow sectors. The areas and sectors ETFs track now include financial, material, utilities, technology, industrial, consumer staples, consumer discretionary, and communications. Sector trading has become popular. There are even contracts for differences that provide CFD trading that follow the movements of individual sectors. ETFs also track the movements of individual commodities such as oil or gold. Recently the U.S. SEC allowed an ETF to track the movements of Bitcoin futures. The futures contracts are listed on the Chicago Board of Trade.

ETFs advantages include portfolio diversification
ETFs advantages include portfolio diversification

What are the Attributes of ETFs?

ETFs provide several advantages compared to traditional open-end funds. They provide trading flexibility, allowing investors to buy and sell the ETF intraday. Conventional open-end mutual funds allowed investors to change once a day. You could enter or exit at the closing price calculated using the Net Asset Value (NAV). The introduction of ETFs allows investors to trade intraday using short-term trading strategies such as CFD trading strategies. If you wanted to sell intraday using a traditional open-end fund, you could not.

ETFs also provide access to risk management. You can use ETFs to hedge your exposure if you are a portfolio manager. For example, if the stocks you own are in the energy sector, you can use an ETF that holds many of those stocks to offset the movements of a group of energy shares. You might even consider a pair trading strategy where you purchase a stock in the financial sector and sell an ETF against it, betting that the individual shares will outperform the ETF.

ETFs also have a lower operating cost than many structures. The expenses include management fees, custodial fees, and administrative fees. Generally, the costs associated with ETFs are lower than other open-end funds. ETFs also save money on monthly statement costs and transfer costs. Since retail investors purchase ETFs through their broker accounts, the broker is responsible for issuing any statement instead of the ETF issuer.

ETFs also provide some tax benefits. Their structure allows investors to receive qualified dividends if they hold an ETF for more than 60-days in the United States. Qualified dividends are generally taxed at a lower rate than unqualified dividends.

Actively Managed ETFs

ETFs will track the movements of stocks, commodities, currencies, and cryptocurrencies. They also can be used to create trading strategies. Some ETFs are actively managed and provide investors with specific trading strategies. You can also create your CFD trading strategy using an ETF, as you track the movements of an underlying instrument or sector.

The Bottom Line

The future of ETFs appears to be bright. ETFs provide investors with instruments that create flexibility, tax advantages, and risk management. You can use an ETF to track the individual movements of an index or a sector. ETFs track commodities, currencies, and even cryptocurrencies. As new assets are created, ETFs can provide access to retail investors. You can also use an ETF to hedge your risk exposure. ETFs allow investors to offset their risk using a flexible asset that tracks the movements of specific underlying assets. ETFs are also cost-effective. Fees are generally less than those charged by standard open-end funds.