Last week, we wished exchange-traded funds (ETFs) a happy 25th birthday. It was March 9, 1990, when the very first was listed on the Toronto Stock Exchange in the form of the TIPs (Toronto 35 Index Participation Fund) and since that time the investment landscape has shifted dramatically.
Along with a steady rise in the number of retail investors in the market, institutional investors—particularly pension funds—have been dogged by two major market corrections, a financial crisis, and a series of regulatory and demographic changes that have made DB pension plans a rarity.
ETFs have fit right in along the way and they’ve grown up as investors adjust to these new realities. In the four years since I started writing this column, I’ve seen ETFs rise to prominence in the investment portfolios of some of the most sophisticated investors in the world. They’ve been blamed for market volatility, attracted some serious regulatory scrutiny and have even been used as a key policy tool by major governments (think Japan).
To illustrate how prominent ETFs have become in global capital markets, one need only scan the investment headlines throughout the week to see what role they’re playing. Here are just three I found this week:
- “Institutions Pour Cash Into Bond ETFs” – This headline is from the Wall Street Journal and it’s not the first such one—institutional investors on the hunt for liquid ways to access fixed income in a post-2008 regulatory environment drove record inflows into bond ETFs. This year up to Feb. 26, bond ETFs took in US$32 billion globally, with $20 billion of that going to a single provider, BlackRock. The key take-away here: ETFs are now of central importance to some of the biggest investors in the world as they grapple with a severe reduction in corporate bond liquidity as banks reduce their supply due to rules around risk-taking.
- “Attack of the Algorithms” – Smart beta ETFs seem to exist in the grey area between active and passive investing. This article in Bloomberg talks about the stellar growth in smart beta ETF assets that focus on factors such as value, momentum and growth. Dorset Wright & Associates’ founder Tom Dorsey claims his firm’s smart beta ETFs are basically rebalanced every few months by “pushing a button.” As smart beta ETFs help investors break away from the broad index, there are some (like Burton Malkiel) that think they’re active management in disguise. In the ETF world, this is one debate to watch over the next 25 years.
- ETF assets reach record highs – Global ETF assets hit US$2.919 trillion—the most ever at the end of February. There are now 5,632 ETFs from 245 providers listed on 63 exchanges in 51 countries. And while total ETF assets are still a fraction of what global mutual funds hold, they are growing in importance, particularly as institutional use grows.
While the ETF space remains small compared to other areas of the market, it will grow and evolve. In some ways, it feels as if we’re at an inflection point where new strategies and greater acceptance among institutions will ultimately take ETF growth to a new level. What that means for investors and market remains to be seen, but if we go by what’s happened over the last 25 years, it’s bound to be an interesting journey.