Cathie Wood became a household name among investors when her ARK Innovation ETF jumped from $37 in March 2020 up to $154.50 in February 2021. The Exchange-Traded Fund was the most prominent example of an Actively Traded ETF — basically a way for the average investor to buy stock in a fund managed by a prominent investor. The 150% growth turned heads on Wall Street and among the growing class of individual retail investors. The ETF — originally conceived as a diversification play for those who couldn’t afford access to a mutual fund — was suddenly viewed as a growth investing opportunity.
An Exchange-Traded Fund is a collection of securities traded as a single stock. ETFs traditionally track either an index, sector, or commodity. The best known of the passively traded ETFs is the SPDR S&P 500 ETF (SPY) which allows traders to hold the entire S&P 500 Index. Launched in January 1993, SPY was the first ETF listed in the United States. It has gained prominence because of its relatively low management costs and its reliable growth.
Mutual Funds and ETFs are similar in that they’re both professionally managed baskets of stocks that provide diversification for investors and the opportunity to realize a reliable, stable growth. The difference is that many mutual funds have a much higher barrier to entry: most Vanguard mutual funds have a $3,000 initial investment compared to single stocks of ETFs which can cost as little as $50. The final difference is that ETFs can be traded any time the market is open whereas mutual funds can only be sold for the price at the start of the day’s trading.
The rise of ETFs was powered by the appeal of the Passive ETF. There are hundreds of varieties of ETFs that track indexes or specific sectors. They give investors a means to (relatively) safely bet on the rising tide of an entire index or sector — a good example is the 11 SPDR Sector ETFs, which offer baskets of equities in sectors like Energy (XLE), Health Care (XLV), Real Estate (XLRE), and Technology (XLK).
For the first 25 years of the ETF, it was these passively traded ETFs that were the star of the show. They provided a cheap entry and reliably outperformed actively traded portfolios. But, accentuated by the rise of Cathie Wood’s ARK Innovation ETF, this last year has seen a growing cadre of Active ETFs.
According to Bloomberg, 2021 has been the first year in which more Active ETFs have been launched than Passive ETFs. Incredibly, more than twice as many have launched. So, what’s behind the growth?
As Nathan Miller, portfolio manager for New York-based Emles Advisors, told Bloomberg: “It’s almost impossible to start a small to medium hedge fund as a single manager. So we thought why go launch another hedge fund? Let’s launch an actively managed ETF.”
These Active ETFs allow the growing class of app-based day traders the chance to bet on the insights of established investors. Though, whether these investors manage to beat the market remains to be seen. Wood’s ARK Innovation ETF, which had seen explosive growth on the strength of Tesla and other high-growth tech stocks, dropped down below $100 in May. While the Active ETF offers much more potent growth potential, it also provides less stability than the Passive ETF.
Still, as more and more established traders enter the ETF market, it seems likely to continue to grow in prominence for app-based investors. Along with the Active ETFs tied to specific investors, large firms are beginning to launch Thematic ETFs to allow investors to bet on rising tides within specific markets/spaces.
According to the same article in Bloomberg:
“Firms are also ramping up their thematic offerings, which invest according to compelling narratives like autonomous driving or sports betting.
A record 22 thematic funds have launched since the start of the year, including Wood’s $619 million ARK Space Exploration ETF (ARKX) and BlackRock Inc.’s $1.4 billion U.S. Carbon Transition Readiness ETF (LCTU), which set a record in April with the industry’s biggest-ever launch.”
Because ETFs were long positioned as a diversification strategy, they became synonymous with safe, predictable investing. While day traders might try to chase the next meme stock, the Passive ETF was a stable addition to a portfolio that promised a reliable growth pattern with less chance of massive gain but also less chance of devastating loss. Many are drawn to the tempting prospect of beating the market, but the ETF trader traditionally bet on the rising tide lifting all boats. For the past 30 years, it’s become difficult for any individual investor to reliably beat the market. The S&P 500 is variable annually, but has returned an average annual return around 10% for decades.
However, the newer entrants into the ETF market have created the opportunity to invest in styles more traditionally employed in the equities market.
A good illustration of this point are two ETFs offered by iShares. The iShares Russell 1000 Growth ETF bundles growth stocks like Apple, Amazon, Google, Nvidia, PayPal, and Facebook into a single ETF offering. The iShares Russell 1000 Value ETF bundles value stocks like Berkshire Hathaway, Johnson & Johnson, Walt Disney, ExxonMobil, and Bank of America. For decades, investors have argued over the strategy of betting on growth or betting on value — now, via these ETFs, an investor can buy into an entire, diversified portfolio of equities within either investing strategy.
What was once the provenance of hedge funds, only available to the wealthiest investors, has been opened up to the average, app-based investor. The ETF market allows investors to buy and sell single stocks in baskets of stocks organized by established investors.
It will take time to see how the democratization of insights, like the democratization of the market in general, will affect the investing landscape. But the rise of ETFs seems to herald a seachange.
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