As a new political era dawns, the phrase “this is not normal” has become a popular rallying cry. Critics everywhere warn against the “normalization” of radical ideologies or the disruptive behavior of the new U.S. president.
But talking about what’s “normal” in politics is always fraught with bias and subjectivity. So let’s tackle the concept by talking about something totally different: exchange-traded funds, or ETFs. Many readers probably know that ETFs are funds made up of underlying securities or commodities that trade on an exchange all day long, just like a stock.
In addition to the ease of buying and selling, they typically carry lower fees than mutual funds. They also happen to be one of the most disruptive technologies in the world. There's been a huge move among investors from typical, actively managed funds into ETFs, a trend that fills a good chunk of the financial industry with dread.
The history of the ETF is fascinating. The initial concept, as Bloomberg’s Eric Balchunas wrote last year, came out of an 840-page report published by the Securities and Exchange Commission after the 1987 Black Monday stock market crash. The report posited that something like an ETF could have mitigated such a crash by allowing traders to easily take a liquid position in the entire market. A few years later, in 1993, the SPDR S&P 500 ETF Trust was born, and it remains the single biggest ETF to this day.
Although the ETF may have originally been conceived of as a way to gain simple, liquid exposure to the entire market, that narrow vision didn’t last. In 2000, the first ETF was launched that was specifically designed to give investors exposure not to the whole market, but to so-called value stocks, or those that are deemed to be cheap relative to some yardstick such as earnings or dividend yield. In 2002, the first bond ETF was launched. During the past decade there’s been an explosion of ETFs, offering easy, liquid exposure to all kinds of strategies and asset classes worldwide.
For example, an investor can buy the Direxion Daily Junior Gold Miners Index Bear 3X Shares ETF, which takes a triple levered bearish position on a daily basis against small gold-mining stocks. There are currency-hedged ETFs, such as the iShares Currency Hedged MSCI Japan ETF, which lets you take a position in foreign stocks while instantly hedging out the currency exposure.
Goldman Sachs Group Inc. recently launched the Goldman Sachs Hedge Industry VIP ETF, which tracks stocks that are widely held among hedge funds, allowing investors to piggyback on hedge-fund managers' collective wisdom. The list of permutations just goes on and on.
For the first part of 2016, there was a huge rush of baby boomer money into low-volatility ETFs that give investors exposure to the least-volatile stocks in the market. Let’s dive a little bit further into this particular type of ETF.
For a long time, there has been a body of academic finance literature that says a portfolio of low-volatility stocks outperforms the market while also offering more safety.
But the key thing to realize and think about here is that the strategy has been essentially off-limits to most people. How many people, outside of sophisticated traders, would know how to set up a continuous screen for the least-volatile stocks in the market and then turn that screen into a portfolio that continuously rebalances itself? Bear in mind, too, that we're talking about a portfolio of about 100 stocks.