Financial History 143 Fall 2022 - Page 25

fund did not need an asset manager or a board of directors , which kept costs lower .
• It could be traded intraday , just like a stock .
• It had no minimum purchase requirement .
• The annual fees were lower than most comparable mutual funds .
• It was more tax efficient than a mutual fund . When mutual funds sell shares , it usually generates capital gains that become taxable for shareholders . An ETF may have to sell shares to meet investor redemptions , but these sales are made to a market maker ( known as an “ authorized participant ”) and do not create a taxable event .
No Love for ETFs from Wall Street
Despite the advantages , the SPDR did not initially take off . Like Bogle ’ s Vanguard 500 Index Fund , much of Wall Street was not in love with the product .
“ There was tremendous resistance to change ,” said Bob Tull , who was developing new products for Morgan Stanley at the time and was a key figure in the development of ETFs . Mutual funds and broker-dealers quickly realized there was little money in the product . There was a small asset management fee , but no annual shareholder servicing fee . The only thing they could charge was a commission .
It was retail investors , who began buying through discount brokers , that helped the product break out , thanks to a strong marketing push from the Amex .
The SPDR was quickly followed by the MidCap SPDR ( now the SPDR S & P Midcap 400 ETF ) in 1995 . In 1996 , Tull , while still at Morgan Stanley , helped launch a series of 17 products , World Equity Benchmark shares ( WEBS ), that tracked indexes tied to different countries .
These new products differed in one important way from the SPDR products : they were structured as an open-end fund , rather than a Unit Investment Trust ( UIT ). This offered several advantages : dividends could be reinvested , shares could be lent out and open-end funds had an asset manager that wasn ’ t required to own each company in the index in exact proportion to the weighting in the S & P 500 .
The Right Product at the Right Time
While it started off slowly , the ETF business came along at the exact right moment . Its growth was aided by a confluence of two events : 1 ) the growing awareness that indexing was a superior way of owning the market over stock picking ; and 2 ) the explosion of the internet and dot-com phenomenon , which helped the S & P 500 rocket up an average of 28 % a year between 1995 and 1999 .
In 1997 , there were just 19 ETFs in existence ( 17 of which were international products , the WEBS ). By the end of 2000 , there were 80 . The dot-com bust slowed down the entire financial industry , but within a few years the number of funds began to increase again .
The Gold ETF Makes Commodity Investing Viable
The year 2004 was an important year for the ETF business . The market was coming out of its 2000 dot-com funk , and the ETF business was growing again . It was a year one of the world ’ s most recognizable investments — gold — was available to buy as an ETF .
Investors who wanted to own gold had limited choices up until then . They could own gold bars or gold coins , but storage was not an easy matter . They could own gold futures , but that involved another layer of complexity . They could own gold mining stocks , but there was an imperfect relationship between gold and gold stocks .
When the StreetTracks Gold Shares ( now called SPDR Gold Shares , symbol GLD ) went public on November 18 , 2004 , it represented a quantum leap in making gold more widely available . The gold was held in vaults by a custodian . It tracked gold prices well , though as with all ETFs there was a fee ( currently 0.4 %). It could be bought and sold in a brokerage account , and even traded intraday .
The ETF Business Takes Off
The GLD was the first commodity-based ETF in the United States , but others quickly followed . The entire ETF industry benefitted from increasing awareness that active management was not , for the most part , producing market-beating returns .
Bogle was slowly winning the argument . From almost nothing in 1996 , ETF assets under management in the United States went up almost 400 % between 2000 and 2005 . ETFs gained even more adherents after the Great Financial Crisis in 2008 – 2009 , which convinced more investors that trying to beat the markets was futile .
ETFs : Poised to Take Over from Mutual Funds
After pausing during the Great Financial Crisis , ETF assets under management took off and have been more than doubling every five years .
US ETF assets under management
1996 $ 2.4 billion 2000 $ 65.5 billion 2005 $ 300.8 billion 2010 $ 991.9 billion 2015 $ 2.1 trillion 2020 $ 5.5 trillion
Source : Investment Company Institute
The Covid pandemic pushed even more money into ETFs . By the end of 2021 , over $ 7 trillion was in US-based ETFs . The mutual fund industry still had significantly more assets ( about $ 23 trillion ), but that gap is closing fast . From a measly 80 ETFs in 2000 , there are now over 2,200 ETFs operating in the United States .
Mutual funds , by contrast , have seen their numbers decline in the past 20 years , even as the dollar value has risen due to the rise in the stock market .
“ ETFs are still the largest growing asset wrapper in the world ,” said Tull , who has built ETFs in 18 countries . “ It is the one product regulators trust because of its transparency . People know what they are getting the day they buy it .”
Bob Pisani is Senior Markets Correspondent for CNBC . A CNBC reporter since 1990 , he has covered Wall Street and the stock market for over 25 years . In addition to covering the global stock market , he also covers IPOs , ETFs and financial market structure for CNBC . He is a member of the Museum of American Finance ’ s Board of Trustees and the author of Shut Up and Keep Talking : Lessons on Life and Investing from the Floor of the New York Stock Exchange ( Harriman House , 2022 ), from which this article has been adapted .
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