February 20, 2020
When the first exchange-traded fund (ETF) was launched on January 22, 19931 few could have imagined the juggernaut this form of investing would quickly become. As of the end of 2019, ETF assets had rocketed to reach some $6.3 trillion, globally2 with growth showing no signs of letting up any time soon.
27 years and counting: making the case for ETFs
Given the relative tax efficiency of the product – whereby investors are generally not affected by the liabilities related to the redemptions made by other shareholders – it is easy to understand their popularity. Liquidity, transparency and pricing are also compelling reasons cited in favour of ETFs.
Investors have found plenty of uses for ETFs since their introduction. Being tradeable intraday, ETFs can enable quick investment in a diversified set of securities and asset classes at a relatively low cost (compared to the majority of traditional mutual funds).
Investors can also utilize ETFs as long-term core holdings, as an expression of tactical asset allocation views or as a means of gaining low-cost exposure to a more esoteric asset class. The possible applications are vast.
Do your homework
If we look beyond the fund structure itself, however, we can see not all ETFs are created equal. Indeed, there are a number of factors investors need to consider when selecting one. For instance, while a range of passive ETFs might all claim to follow the exact same index/benchmark, the returns in each are unlikely to be identical. Among the factors that may impact relative individual ETF returns are:
- Their respective expense ratios
- Tracking errors relative to the benchmark
- The bid-offer spread an investor pays to purchase or sell the ETF shares
Investors will also notice the returns of their ETF habitually lag their designated benchmark or index. This is because any underlying index which the ETF is tracking, itself does not incur any transaction costs when constituents enter or exit. Neither does an index trade with a bid-offer spread (the difference between the price point at which someone is prepared to sell a share and that at which they are prepared to buy). Liquidity has a crucial influence on ETF costs. So when looking for the most competitive ETFs, investors may lean towards larger funds. Generally, the greater the trading volume in an ETF, the tighter the bid-offer spread.
In some ETFs, the combination of costs such as those outlined above typically add up to less than 1% of its value. With this in mind it is important investors do their homework. Some ETFs may have overall low expense ratios relative to their size, modest trading costs and tight bid-offer spreads.
The appeal and investor use of ETFs is wide ranging – from those using it as a relatively low-cost diversification tool to those who prefer to invest in such products as a core investment.
1 Investopedia. A Brief History of Exchange-Traded Funds. August 25, 2019.
2 FT: ETF providers end 2019 on high with record assets (Investors ploughed $570bn into products bringing global total to $6.3 trillion). January 13, 2020.
Investors should consider the investment objectives, risks, charges and expenses of a fund carefully before investing. To obtain a prospectus, or a summary prospectus, if available, that contains this and other information about a fund, contact your financial advisor or visit im.bnymellon.com. Please read the prospectus carefully before investing.
ETF shares are listed on an exchange, and shares are generally purchased and sold in the secondary market at market price. At times, the market price may be at a premium or discount to the ETF's per share NAV. In addition, ETFs are subject to the risk that an active trading market for an ETF's shares may not develop or be maintained. Buying or selling ETF shares on an exchange may require the payment of brokerage commissions.
ETFs trade like stocks, are subject to investment risk, including possible loss of principal. The risks of investing in the ETF typically reflect the risks associated with the types of instruments in which the ETF invests. Diversification cannot assure a profit or protect against loss.
Bonds are subject to interest rate, credit, liquidity, call and market risks, to varying degrees. Generally, all other factors being equal, bond prices are inversely related to interest-rate changes and rate increases can cause price declines. High yield bonds involve increased credit and liquidity risk than higher rated bonds and are considered speculative in terms of the issuer’s ability to pay interest and repay principal on a timely basis.
Equities are subject to market, market sector, market liquidity, issuer, and investment style risks to varying degrees. Small and midsized company stocks tend to be more volatile and less liquid than larger company stocks as these companies are less established and have more volatile earnings histories.
Investing in foreign denominated and/or domiciled securities involves special risks, including changes in currency exchange rates, political, economic, and social instability, limited company information, differing auditing and legal standards, and less market liquidity. These risks generally are greater with emerging market countries.
Past performance is no guarantee of future results.
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Views expressed are those of the author stated and do not reflect views of other managers or the firm overall. Views are current as of the date of this publication and subject to change. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission.
BNY Mellon Investment Management is one of the world’s leading investment management organizations and one of the top U.S. wealth managers, encompassing BNY Mellon’s affiliated investment management firms, wealth management organization and global distribution companies. BNY Mellon is the corporate brand of The Bank of New York Mellon Corporation and may also be used as a generic term to reference the Corporation as a whole or its various subsidiaries generally. BNY Mellon ETF Investment Adviser, LLC is the investment adviser and BNY Mellon Securities Corporation is the distributor of the ETF funds, both are subsidiaries of BNY Mellon.