The creation of the ETF SPY was the zero to one moment with Nate Most as our Bill Gates. And the result was fresh and strange and very misunderstood for a long time. Only now (26 years after the launch of SPY) is the ETF becoming mainstream and fairly well understood by the large majority of investors. That’s not to say we aren’t still debunking misunderstandings, but those misunderstandings and false statements are squarely driven by the minority now. And as we know with most technological advances, there is a minority that will always insist the old way is better.
Every moment in business happens only once. The next Bill Gates will not build an operating system. The next Larry Page or Sergey Brin won’t make a search engine. And the next Mark Zuckerberg won’t create a social network. If you are copying these guys, you aren’t learning from them. Of course it’s easier to copy a model than to make something new. Doing what we already know how to do takes the world from 1 to n, adding more of something familiar. But every time we create something new, we go from 0 to 1. The act of creation is singular, as is the moment of creation, and the result is something fresh and strange.
- Transparency: Relative to previous pooled investment vehicles (hedge funds/mutual funds/ PE funds/ private REITs, etc), ETFs are more transparent. There are a number of ways ETFs and the ETF industry are more transparent. The biggest way is that almost all ETFs have their holdings published on a daily basis on their company’s website. A second major reason ETFs are considered transparent is investors can easily understand the fee. ETF fees are stated clearly and all investors in the fund pay the same fee. Transparency (of both holdings and fees) seems fairly blasé, but this transparency enables investors to know what they own and exactly what they are paying for. 2
- Lower Costs (to operate): Exchange Traded Funds, in general, have lower operating costs than mutual fund (and therefore lower costs on average for investors. ETFs are the driving force behind savings of approximately $266 billion through 2017).
- Tax Efficiency: The third major change brought by the ETF structure is that ETFs are typically more tax efficient (to an estimated 0.8% per year in tax deferral relative to the average mutual fund). With an ETF, you are much more likely to only pay taxes when you decide to sell (defer your taxes), as opposed to the mutual fund structure where you are often consistently having to pay taxes on capital gain distributions (and this is out of your control). The ability to control your own taxes is a major win for investors and how it should be.
What Can We Expect in the Future for the Asset Management Industry?A key question from people in the ETF industry is when will the mutual fund die? Turns out its a bit more complex than many of us in the ETF industry would like to admit. For years the story is that the ETF industry is booming and the mutual fund industry is struggling. While this is directionally correct, looking at some charts may help give us a little more color on the stats behind the story and find the answer may be murkier than we expected.
- People are turning mutual fund investments into retirement spending.
- Mutual fund assets are moving into CITs.
- ETFs benefit from substitution effect–used in lieu of single securities and derivatives 4
ETFs for the FutureThe charts above show you can make a solid case either way. You can look at the flows chart and say its evidence ETFs are throttling the mutual fund industry, or you can say most of the outflows in mutual funds are due to structural reasons of retired owners selling to generate income. You can look at the assets under management chart as being a massive opportunity for ETFs to continue to gather
mostobvious example being gold ↩
- This wasn’t the case in almost every (every?) pooled investment vehicle before the ETF. Investors would buy a mutual fund or hedge fund and have to just trust the fund manager was going to be doing what they said as holdings are only shown once a quarter. And good luck trying to figure out what you’re actually being charged if you invest in private REITs: hidden fees out the wazooooo! ↩
- And yes, some of these assets flowed through to index/low cost mutual funds, but the ETF structure was the biggest driver. Without the legacy baggage the mutual fund companies had/have, the ETF industry greatly accelerated change by enabling new asset management companies to start, gain scale, and shake up the investment industry. This rethink of asset management companies is
thebiggest benefit the ETF companies brought. Even bigger than the structural benefits mentioned above. ↩
- A list within a list?! I’m not sure if this is allowed, but with so many Buzzfeed employees laid off, someone has to step up on the internet superhighway and fill in the gap ↩