Mutual fund companies are in their second year of tough times, with another difficult year in the equity markets. However, investment giants-like Barclays Global Investors, State Street Global Advisors, Bank of New York and Vanguard-continue to experience increasing interest in ETFs. Popular ETFs include benchmark indexes like the Dow Jones Industrial Average (Diamonds), NASDAQ 100 (QQQs) and the S&P 500 (SPDRs or iShare S&P 500).
ETFs are exchange traded index funds that can be bought and sold like equity shares of listed public companies. Unlike traditional mutual funds, which are priced once per day after the market closes, ETFs can be bought or sold at market prices any time the exchanges are open. As index funds, ETFs track equity indexes real time, which means investors can mimic the performance of an entire index-the Dow Jones Industrial Average, for example, or the S&P 500-by purchasing a single equity security.
Because ETFs are open-ended, meaning shares of the funds can be redeemed or created daily, but only in large institutional-sized share blocks representing millions of dollars, shares tend to trade at or close to their underlying indicative net-asset value or portfolio trading value. This is because professional arbitrageurs, like stock exchange specialists, stand ready to take advantage of a significant premium or discount relative to the underlying index.
The current generation of ETFs is passive, low-cost and generally very tax-efficient. ETFs are purchased through a broker-dealer and involve brokerage commissions. ETFs are not only good short-term trading vehicles, but their low cost and high tax efficiency also make them ideal as long-term core investment vehicles. Index-based ETFs are frequently confused with HOLDRs (pronounced "Holders"), which are baskets of 20 or so stocks assembled around a common investment theme or industry sector. HOLDRs do not seek to mimic a particular equity index, but like ETFs, are low-cost and tax-efficient.
More advisors are finding ETFs useful investments for clients due to their low cost-many benchmark-indexed ETFs have expense ratios of less than 25 basis points per year-and high tax efficiency compared with actively managed funds or even low-cost index mutual funds. Firms such as A.G. Edwards, Prudential and Guardian Advisors have introduced wrap-fee, asset-allocation accounts that hold only ETFs.
Assets in ETFs in the United States increased from $65.7 billion to $84.6 billion last year. As of year-end, there were 101 ETFs listed in the United States, with 21 new funds introduced in 2001 alone. These funds are listed on the American Stock Exchange, the Chicago Board of Options and the New York Stock Exchange. ETFs are traded on all national exchanges and many regional exchanges. ETFs such as the QQQs and SPDRs frequently are the most actively traded stocks in the United States Among the major developments in 2001 were the introduction of Vanguard's VIPER share class of ETFs and Barclays' fixed-income ETFs.
European investors also have jumped upon the ETF bandwagon. There currently are 71 ETFs listed in Europe, of which 65 were introduced in 2001. Many European ETFs are cross-listed in London, Frankfurt, Paris, Switzerland and Amsterdam. There are ETFs based upon most national indexes and many industry sectors. Assets in European ETFs grew from some $670 million to more than $5.5 billion. Merrill Lynch, State Street Global Advisors, Barclays Global Investors, Hypoverinsbank, SocGen, UBS and Credit Suisse issue ETFs in Europe to name just a few. ETFs also are traded in Canada, Israel and in the Far East in Australia, Japan, Hong Kong and Singapore.
Expect ETFs to continue to be one of the fastest growing areas in investment management in 2002. Look for the introduction of more sector products, enhanced index funds and fixed-income funds in the United States. The most dramatic development would be the introduction of actively managed ETFs. Regulators at the Securities and Exchange Commission are studying these vehicles closely before giving them the green light. Expect more funds companies to get into the fray as new money continues to flow into these products.
James Pacetti is president of www.exchangetradedfunds.com.