ETFs have become increasingly popular trading instruments over the past few decades. Let’s take a look at where they came from, how much they’ve evolved since then, and why investors are sticking with them.
The first ETF
The first ETF in North America was launched in 1993 when State Street Global Advisors introduced S&P 500 SPDRs. Unlike traditional mutual funds, which require continuous capital investments to increase exposure in stocks or bonds, ETFs can be purchased on public exchanges just like any other stock.
Because their prices are updated every second, unlike mutual stocks or bonds, ETFs appear to trade at prices equal to their assets minus liabilities divided by shares outstanding: this implies that an investor could theoretically place an infinite bid and ask price for purchases; the ETFs would match them perfectly.
The first S&P 500 SPDR
When the first S&P 500 SPDR was introduced, it cost $869 for a single share equal to the value of 25 shares of underlying stocks. Today you can purchase one share for under $200, so its price has dropped significantly over time – but not necessarily due to decreased demand!
The first ETF gained 31% in 1993 and brought in almost $20 million that year; then it made gains totalling about 100% between 1994-1995 before correcting to just under 5%. Later on, S& P 500 SPDRs were only responsible for bringing in about $1 billion over the next few years before rising again to just shy of $5 billion by 2001.
By 2007, ETFs had become so popular that State Street launched another fund based on the S&P 500, this time called S&P 100 SPDRs. The first day of trading for this new ETF brought in almost $280 million, which is much more than the year’s total for any other single ETF at that time.
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Most popular growth
The most popular growth has been seen with newer “exotic” ETFs – different from the original market-weighted ones because they are not just focused on large, well-established companies. Exchange Traded Concepts saw some success when it introduced emerging markets and real estate securities and commodity funds, or those that focus on oil, gas or metals such as gold and silver. There were already some similar funds before, but ETNs were what gave rise to the commodity ETF market we know and love today.
ETNs are similar to ETFs in that they trade like regular stocks – but there’s a considerable difference: ETNs place your money into debt instruments such as notes or bonds. It means that if anything happens to the issuer of an ETN, you could lose all of your investment. In contrast, with an ETF, even if the company goes bankrupt, you’re still likely to get some return on your original investment because other investors will be interested in buying it up and turning it around for a profit.
Their popularity exploded as traders and investors realized how much more liquid and flexible ETFs were over mutual funds. The first US-listed ETF brought in over $100 billion by 2007, but one year later, that number had almost doubled to $230 billion – and it’s only continued to grow since then.
Today, thousands of ETFs are available on the market, with more than 1,700 funds focusing their attention on bonds while there are just under 600 focused on equity securities. The bond market is much larger than the stock market, so this makes sense, but it leaves plenty of room for growth, too, considering that there are only 40 or 50 equity-focused ETFs. As time goes by, we’re likely to see many more new funds pop up!
It isn’t all due to changes in demand either; although demand has grown exponentially, the products themselves keep getting better. It has made them even more attractive to investors and traders, so the cycle repeats.
Looking back, it’s pretty clear how ETFs came to be – but looking forward, what will be their next significant innovation? Will we start seeing “smart” ETFs that act only when certain conditions are met or tracking indicators that actively measure things like political instability in a country? The sky’s the limit for this industry now that it’s become one of the most significant financial forces behind everything from pop culture to politics.
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