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What is an ETF?

By  +Follow January 21, 2014 9:00AM
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It’s an age-old maxim that is as true today as it ever was: the majority of mutual fund managers fail to beat the market. More specifically, a mid-2012 survey by Standard & Poor’s found that 65 percent of fund managers trading large, blue-chip stocks failed to beat the S&P 500. In fact, the S&P Composite 1500 beat 89.4 percent of mutual funds over the year preceding the study. Oof.

But is that fair to the fund managers? Annualized returns for the S&P 500 are right around 10 percent on average, a rate almost any investor would have to be pretty happy with. Since its inception, the lowest average annual return for the index over any one 25-year period is 9.28 percent. Again, the lowest. The best annualized return over any 25-year period was 17.25 percent, and the median was 12.98 percent.

Whether or not this qualifies as an indictment of stock-picking as a whole remains up for debate, but anyone looking at the above numbers might come to a rational conclusion: why keep paying fund managers so they can try and fail to beat these benchmarks? What if you could just buy shares in the S&P 500 itself? Wouldn’t you rather just do that?

And the answer to that question came in the form of the Exchange-Traded Funds (ETF) designed to match the performance of an index, thus circumventing the question of outperforming “the market” altogether. Because, after all, if you can’t beat ‘em, join ‘em.

What Are ETFs?

Simply put, an ETF is a portfolio of stocks (or other assets, but more on that later) that are managed by a financial company, or issuer. That company then sells shares of the portfolio to the general public. Which is almost exactly what a mutual fund is.

The key difference in an ETF is that the company managing the portfolio, rather than attempting to maximize returns by selecting those stocks the managers like the most, is trying to replicate the movement of a specified target index. This is notable because it’s actually remarkably easy to do, unlike hand-picking a portfolio that beats the market.

So, for the SPDR S&P 500 ETF ($SPY), by far the most-traded ETF, the goal is to match the movement of the S&P 500. The managers carefully maintain a portfolio that has the same proportions of those 500 stocks as the index, and the results are a fund that tracks the S&P 500 to within tenths of a percentage point.

The same is true for the SPDR Dow Jones Industrial Average ETF ($DIA) and the, you guessed it, Dow Jones Industrial Average. And the Nasdaq Composite Index Tracking Stock (ONEQ) and the Nasdaq Composite. And, at this point, pretty much any other index you can think of and the ETF someone maintains to track it.

Does It Work?

And how do they usually do? Well, given the difference in scale, it’s virtually impossible to perfectly replicate returns, but the people designing ETFs have it down to enough of a science that they come darn close.

From early 2004 to early 2014, the S&P 500 rose 64.76 percent while the SPY gained 64.03 percent. And, from early 1994 to 2014, 20 years that span nearly the entire life of SPY, the index has returned 296.26 percent to the fund’s 294.23 percent. While not perfect, few investors are willing to quibble over those fractions of a percent each year.

The ETF Industry

ETFs have exploded in popularity since their introduction, with over 1,200 different products controlling more than $1 trillion in assets. With so many different options, one can make any number of very broad or very specific bets on a variety of different market conditions using ETFs. There are commodity ETFs to track commodity prices, bond ETFs that track the returns of baskets of bonds, and ETFs focused on very specific industries, like the Robo-Stox Global Robotics & Automation Index ETF ($ROBO), which specifically follows robotics stocks.

The industry for ETF issuers, those companies that take responsibility for creating and maintaining the funds, has also taken off and includes most of the traditional actors in the finance world. However, the most prominent issuer is probably State Street Corporation (STT) , which issues the ever-popular SPDR funds that cover most of the S&P’s sector-specific indices among others. Other major issuers include iShares (a subsidiary of BlackRock (BLK), Guggenheim Funds, Global X Funds, and the Vanguard Group.

Most Popular ETFs

The ETFs that trade the most shares on an average day illustrate the range of uses investors and traders alike have found for the instruments.

Certainly, many of the top 10 most-traded funds represent those offering a chance to make broad, relatively low-risk bets on large indices, like the SPY, the SPDR Financial Select Sector SPDR ($XLF), the iShares Russell 2000 Index ETF ($IWM), which tracks the Russell 2000 Index, and the PowerShares QQQ ($QQQ), which tracks the Nasdaq-100 Index.

However, some of the other high-volume ETFs represent a much more speculative, high-risk approach. The iShares MSCI Emerging Markets Index ETF (EEM) represents an investment in foreign, emerging market equities most would usually avoid in a risk-off environment, and the Market Vectors Gold Miners ETF ($GDX) is made up of gold mining stocks that tend to display wide moves in value in relation to the price of gold. And the iPath S&P 500 VIX Short-Term Futures ETN (VXX) tracks the volatile and little-understood VIX index.

ETFs: A Part of Most Balanced Portfolios

Ultimately, ETFs are a valuable investment and trading vehicle that are flexible and useful. Virtually any investor could most likely compliment their portfolio by understanding and utilizing them, provided that one’s familiar with what they are and how they best fit into a broader investment strategy.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions.


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Results for SPY
★★★★★
22 Oct 14 21:30:01
"@Wavepatterntraders: $SPX $SPY Next up is a puke to point 5? Ghost of 2011 http://t.co/4hJtJyk2D8"
Trade n  Perform
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Amy
22 Oct 14 21:26:58
RT @philstockworld: Will our "Recovery" Run out of Gas? #Stimulus #Steriods #KansasCity #Fed #Kleptocracy #5%Rule $SPY $DIA $IWM -- http:/…
★★★★★
22 Oct 14 21:26:43
$SPY $SPX that's what happens tgt $178-172 http://t.co/3s4SqBxrhM
★★★★★
22 Oct 14 21:24:17
CIT Will SPY Decline After QE3 Ends? $SPY http://t.co/gixd7N2cS6 it should be
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22 Oct 14 21:22:36
$SPY (( my )) tgt now it $178-172 http://t.co/0yT1jUQXvD
Rev Kev
22 Oct 14 21:22:24
RT @philstockworld: Will our "Recovery" Run out of Gas? #Stimulus #Steriods #KansasCity #Fed #Kleptocracy #5%Rule $SPY $DIA $IWM -- http:/…
Chris Siwinski
22 Oct 14 21:20:19
RT @philstockworld: Will our "Recovery" Run out of Gas? #Stimulus #Steriods #KansasCity #Fed #Kleptocracy #5%Rule $SPY $DIA $IWM -- http:/…
Kevin B. Bantz
22 Oct 14 21:13:57
Commented on StockTwits: $SPX $SPY $QQQ $MDY $XLE $BNK $BAC $WFC $DIA $IWM $TZA http://t.co/Iu4w4LbLd9... http://t.co/RdQlyHfL4V
Richard Riggs
22 Oct 14 21:13:06
RT @RyanDetrick: $SPX with no 3% up days the past 3 yrs. Had 19 in '08. Hammers home big moves aren't bullish. $SPY http://t.co/ZjKBgnuINp
STOCKPRO
22 Oct 14 21:12:42
RT @FioritoJarrad: I am short biased tmrw on the markets and most stocks. Going to use over/under 192.35 on the $SPY as a guide.
Wall Street Forecast
22 Oct 14 21:10:47
$SPY $IWM $QQQ -- Clif High has moved the original “Black Monday” forecast for the 13th to the 27th.
Financial eBooks
22 Oct 14 21:09:58
RT @StockTwits: The price of these 2 services has increased the most since 2008: Education +31.6% Medical care +21.2% -> http://t.co/4tH2…
Kelsey
22 Oct 14 21:08:48
RT @philstockworld: Will our "Recovery" Run out of Gas? #Stimulus #Steriods #KansasCity #Fed #Kleptocracy #5%Rule $SPY $DIA $IWM -- http:/…
Hereitfirst
22 Oct 14 21:06:36
how to trade $SCTY $VSR $SPY $TSLA $DRL $NFLX $GOOGL $AMZN $CYBR $BIDU $AAPL $SPY $LAKE http://t.co/uTZpFW8a4K
Colette Nelson
22 Oct 14 21:06:34
RT @philstockworld: Will our "Recovery" Run out of Gas? #Stimulus #Steriods #KansasCity #Fed #Kleptocracy #5%Rule $SPY $DIA $IWM -- http:/…
Lin/林莹君
22 Oct 14 21:04:13
Commented on StockTwits: Soon $SPY is heading to wave C... http://t.co/WpryFdYFdw
Marc Gieselmann
22 Oct 14 21:02:03
RT @philstockworld: Will our "Recovery" Run out of Gas? #Stimulus #Steriods #KansasCity #Fed #Kleptocracy #5%Rule $SPY $DIA $IWM -- http:/…
Wavepatterntraders
22 Oct 14 21:00:04
$SPX $SPY Next up is a puke to point 5? Ghost of 2011 http://t.co/ZolpF4kiJ3
Jeffrey D.
22 Oct 14 20:56:41
RT @philstockworld: Will our "Recovery" Run out of Gas? #Stimulus #Steriods #KansasCity #Fed #Kleptocracy #5%Rule $SPY $DIA $IWM -- http:/…
Chase Miller
22 Oct 14 20:55:48
RT @philstockworld: Will our "Recovery" Run out of Gas? #Stimulus #Steriods #KansasCity #Fed #Kleptocracy #5%Rule $SPY $DIA $IWM -- http:/…
Fake CNBC
22 Oct 14 20:55:09
RT @RyanDetrick: Seems like happens all the time anymore, but '14 just 14 $SPX 1% up days. Lowest since 2006. $SPY http://t.co/VPUfaaWh4Z
Laura
22 Oct 14 20:52:57
RT @philstockworld: Will our "Recovery" Run out of Gas? #Stimulus #Steriods #KansasCity #Fed #Kleptocracy #5%Rule $SPY $DIA $IWM -- http:/…
ASTRO
22 Oct 14 20:51:58
RT @philstockworld: Will our "Recovery" Run out of Gas? #Stimulus #Steriods #KansasCity #Fed #Kleptocracy #5%Rule $SPY $DIA $IWM -- http:/…
Bullbusters steven
22 Oct 14 20:51:48
RT @RyanDetrick: $SPX with no 3% up days the past 3 yrs. Had 19 in '08. Hammers home big moves aren't bullish. $SPY http://t.co/ZjKBgnuINp
Becky Hiu
22 Oct 14 20:49:44
$XLU sector - the underlyings all look game for a breakout! On watch tomorrow. When this sector goes south too, watch that $SPY ;)
Don Wyper
22 Oct 14 20:48:03
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Ann Barrow
22 Oct 14 20:47:55
RT @philstockworld: Will our "Recovery" Run out of Gas? #Stimulus #Steriods #KansasCity #Fed #Kleptocracy #5%Rule $SPY $DIA $IWM -- http:/…
Action Trades
22 Oct 14 20:45:45
RT @momotrader: Excellent! - a great correlation chart. If oil goes under $80, mkt pain awaits >> RT: @TraderRL23: $USO $IWM $SPY http:…
Doug Seaman
22 Oct 14 20:44:16
RT @CrackedMarket: Today's weakness doesn't mean much unless we fall under this level: http://t.co/hkhTpGDwo3 $SPY $SPX $ES_F
Joshua Minnich
22 Oct 14 20:44:13
RT @philstockworld: Will our "Recovery" Run out of Gas? #Stimulus #Steriods #KansasCity #Fed #Kleptocracy #5%Rule $SPY $DIA $IWM -- http:/…
#60SecsB4Takeoff
22 Oct 14 20:43:34
RT @philstockworld: Will our "Recovery" Run out of Gas? #Stimulus #Steriods #KansasCity #Fed #Kleptocracy #5%Rule $SPY $DIA $IWM -- http:/…
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Comm
22 Oct 14 20:40:35
RT @philstockworld: Will our "Recovery" Run out of Gas? #Stimulus #Steriods #KansasCity #Fed #Kleptocracy #5%Rule $SPY $DIA $IWM -- http:/…
momotrader
22 Oct 14 20:39:38
Excellent! - a great correlation chart. If oil goes under $80, mkt pain awaits >> RT: @TraderRL23: $USO $IWM $SPY http://t.co/i2OQ16523q
Becky Hiu
22 Oct 14 20:39:33
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Wall Street Forecast
22 Oct 14 20:37:47
$SPY & other closing trades today. http://t.co/2wO7MxmEEa
StockPickPanda
22 Oct 14 20:37:31
ES $SPY cc: @TradingMemes http://t.co/KEBYQK1WNt
Jarrad Fiorito
22 Oct 14 20:36:31
I am short biased tmrw on the markets and most stocks. Going to use over/under 192.35 on the $SPY as a guide.
CrackedMarket
22 Oct 14 20:36:14
Today's weakness doesn't mean much unless we fall under this level: http://t.co/hkhTpGDwo3 $SPY $SPX $ES_F
stephen moran
22 Oct 14 20:36:12
Chart for Study: $SPY - What first - 50 DMA or 200 DMA http://t.co/wsGdjHvUv2 via @weebly
William Buck
22 Oct 14 20:32:59
RT @RyanDetrick: Oct living up to reputation as most volatile mo. 4 of 10 best and 4 of 10 worst days in Oct. $SPY http://t.co/O10Y39pU8K
Con Todo Lujo
22 Oct 14 20:29:18
RT @StockTwits: The price of these 2 services has increased the most since 2008: Education +31.6% Medical care +21.2% -> http://t.co/4tH2…
Ryan Detrick, CMT
22 Oct 14 20:26:54
(correct chart) $SPX 1% up days per yr. Just 14 in '14 is lowest since 2006. $SPY http://t.co/qPqhiNbICH
Jonathan Whitcraft
22 Oct 14 20:26:17
RT @RyanDetrick: Seems like happens all the time anymore, but '14 just 14 $SPX 1% up days. Lowest since 2006. $SPY http://t.co/VPUfaaWh4Z
Benjamin Kong
22 Oct 14 20:25:30
CIT Will SPY Decline After QE3 Ends? $SPY http://t.co/NsyviXC8v9
Gerardo Benitez
22 Oct 14 20:24:40
RT @RyanDetrick: $SPX with no 3% up days the past 3 yrs. Had 19 in '08. Hammers home big moves aren't bullish. $SPY http://t.co/ZjKBgnuINp
Ryan Detrick, CMT
22 Oct 14 20:24:06
Seems like happens all the time anymore, but '14 just 14 $SPX 1% up days. Lowest since 2006. $SPY http://t.co/VPUfaaWh4Z
SureTrader
22 Oct 14 20:22:56
RT @RyanDetrick: Since '70, October avg daily $SPX move is 0.92%, the most for any month. $SPY http://t.co/0TK6mOBMSw
				
				
By  +Follow January 21, 2014 9:00AM
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