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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
464W
23 Aug 14 12:48:50
Market Report: Indicators Are Cued Up For A Bear Market $SPY. Four long term indicators suggest market overbought. http://t.co/5xlTH0EGXr
Charles McDonald
23 Aug 14 12:47:52
RT @TV_TradingIdeas: for my records $SPY http://t.co/E3dH1wlIKf
Financial News
23 Aug 14 12:47:34
$SPY: SPY Trends and Influencers August 23, 2014 http://t.co/wFNM3pPZoO http://t.co/hzYdY2Dllu
TV_Trading Ideas
23 Aug 14 12:46:48
for my records $SPY http://t.co/E3dH1wlIKf
The Whole Street
23 Aug 14 12:45:23
Current rally of similar character to recent junctures after shallow corrections $SPY… http://t.co/GEB6DBmdac
steven spencer
23 Aug 14 12:42:34
how the $SPY behaved in late summer fall of 2011 not similar at all to December 2012 to present....
steven spencer
23 Aug 14 12:41:41
when doing back tests for $SPX probably best to do 32 mo's. this should give relevant trading data for current market regime. $SPY
RMB Investor
23 Aug 14 12:41:19
RT @StockTwits: Endorse--> "@jessefelder: Lots of weekly market summaries out there. Few do it as well as @ukarlewitz http://t.co/hg5jR5r0q…
Mark K
23 Aug 14 12:39:13
RT @RyanDetrick: Since '50, the most bullish 5-day period is Oct 27-Nov 1. Up +1.70% on average. $SPY
Mark K
23 Aug 14 12:39:09
RT @RyanDetrick: Since '50, the worst 5-day return is from Sept 19-24. $SPX down -1.04% on average. $SPY
Mark K
23 Aug 14 12:34:30
RT @RyanDetrick: Here's what avg August since '50 looks like. That weak till a big bounce on last day of month. $SPY http://t.co/1RCSCBB3Yj
specvestor
23 Aug 14 12:33:20
Stock buy backs going down: $SPY $ES_F $QQQ #stockaction http://t.co/iV3dvuxxBe
Ryan Detrick, CMT
23 Aug 14 12:32:24
Here's what avg August since '50 looks like. That weak till a big bounce on last day of month. $SPY http://t.co/1RCSCBB3Yj
CodyHindSTA
23 Aug 14 12:28:02
Emini Day Trading Series: What You Need to Start Day Trading http://t.co/Po3XhK82hh $ES_F $SPY $SPX
Ryan Detrick, CMT
23 Aug 14 12:26:10
Since '50, the worst 5-day return is from Sept 19-24. $SPX down -1.04% on average. $SPY
TV_Trading Ideas
23 Aug 14 12:23:44
SPDR S&P 500 ETF $SPY http://t.co/Zmzggc3vL1
Ryan Detrick, CMT
23 Aug 14 12:23:22
Since '50, the most bullish 5-day period is Oct 27-Nov 1. Up +1.70% on average. $SPY
Balázs Lukucz
23 Aug 14 12:23:20
RT @RyanDetrick: Hearing lots of talk how last 5 days of August are bearish. Since '50, if bought for final 5 days you'd be down -0.11% on…
Ryan Detrick, CMT
23 Aug 14 12:20:26
Hearing lots of talk how last 5 days of August are bearish. Since '50, if bought for final 5 days you'd be down -0.11% on avg. $SPY
Eyang Sukur
23 Aug 14 12:20:15
RT Fractal Forex FA_Forex : Tell us what you think about this weeks $SPY alert. How are you trading it? http://t.co/XtWmKiFi9w 
TheClosingBell
23 Aug 14 12:19:29
Get ready for next with our free daily news letter. http://t.co/mqF8NZmDjF $eurjpy $eurusd $gbpusd $gbpjpy $usdjpy $audusd $spy $twtr $fb
Fractal Forex
23 Aug 14 12:19:02
Tell us what you think about this weeks $SPY alert. How are you trading it? http://t.co/MALgptQ6m3
Equity Sense
23 Aug 14 12:14:08
You got the fire, we can take it higher! Fall's coming, help us help you @ http://t.co/U5cjfJ3sOY $aapl $bbry $tsla $eurusd $es_F $spy
Gavin Martinsson
23 Aug 14 12:14:08
You got the fire, we can take it higher! Fall's coming, help us help you @ http://t.co/dPCTk2APEC $aapl $bbry $tsla $eurusd $es_F $spy
Mike Lim
23 Aug 14 12:14:03
You got the fire, we can take it higher! Fall's coming, help us help you @ http://t.co/mBX2O6gnJA $aapl $bbry $tsla $eurusd $es_F $spy
SLV Fractalerts
23 Aug 14 12:11:22
Tell us what you think about this weeks $SPY alert. How are you trading it? http://t.co/crjHs24jKs
The LincolnList
23 Aug 14 12:04:28
Looking to make trading a career? We can train and fund you Learn more here http://t.co/tKLoCXQzCy $SPY
Social Alpha Inc
23 Aug 14 11:59:33
Stocks buzzing on social media: $ONE $GAIN $RT $HEP $IGN $AAPL $GSPC $SPY. Trade social sentiment @ http://t.co/K98K1bULdq #tradeSentiment
Maximus Analysis
23 Aug 14 11:55:25
Weekly stock Analysis $SPY $QQQ $PCLN $AAPL $NFLX $BAC and others http://t.co/IHx6qAB2LZ
Maximus Analysis
23 Aug 14 11:54:42
Weekly Stock Analysis Video http://t.co/osyl9XM2Et $SPY $QQQ $AAPL $NFLX $TSLA $BAC $PCLN http://t.co/2fkBdOLpbP
Vincent
23 Aug 14 11:52:00
Weekly market summary from fat-pitch blog: http://t.co/KrGZiVjtt9 $SPY $IBB $STUDY
Market Updater
23 Aug 14 11:47:33
$SPY: A Market to Kill For: S&P 500 Gains Most Since April; Nasdaq at 14-Year High http://t.co/ViA8MD3cEk http://t.co/vGJI95I466
Bruce J Moschella
23 Aug 14 11:46:44
$YM_F $ES_F $NQ_F $TF_F $SPY $QQQ On the Private stream if you need additional analysis let me know. http://t.co/6HFOQcrrVo
Family Investor
23 Aug 14 11:45:28
Market and Meaning – The Week Ahead http://t.co/DPnwRkBTp4 $SPY $GLUU $GTAT $INVN #stocks #investing #ISIS http://t.co/8Cs18Hcxvf
Bucky_36
23 Aug 14 11:43:35
RT @StockTwits: Endorse--> "@jessefelder: Lots of weekly market summaries out there. Few do it as well as @ukarlewitz http://t.co/hg5jR5r0q…
LouisLouie
23 Aug 14 11:34:09
“@RaffaellaDeFili: Merkel Seeks to Defuse Ukraine Crisis as Convoy Returns to Russia http://t.co/gdxfwEfO0Y via @WSJ”$gld $gdxj $jdst $spy
Nico A. Inberg
23 Aug 14 11:24:37
RT @FranksView: Scarry how economists publicly help to inflate the bubble “@Nico_A_Inberg: 5 Reasons Why This Rally Is Not Over http://t.co…
Bruce J Moschella
23 Aug 14 11:22:34
$YM_F $ES_F $NQ_F $TF_F $SPY $QQQ Weekend Update has been published. Looking for market direction come join. http://t.co/WCIaCcM2n0
James Black
23 Aug 14 11:14:36
RT @philstockworld: #Fed 's #JacksonHole Conference a Big F U to the Bottom 90%: $SPY $DIA $GLD #TGIF -- http://t.co/sIAsogfTYp
Tommy The Trader
23 Aug 14 11:14:14
$SPX $SPY - Needs to rest a bit, quite a recent move…#daytrading #S&P500 http://t.co/oiowdT2YYg
The LincolnList
23 Aug 14 11:04:28
What does it mean by " Being Ready For Opportunity?" http://t.co/PhMURQG8QA $SPY $Z $AAPL
Winnetou Weinstein
23 Aug 14 11:02:25
RT @TrendTrader4u: Why traders follow $SPY ? Because it's the benchmark of the market. $DIA is only blue chip, $IWM only small caps, $QQQ m…
Edward Gofsky
23 Aug 14 10:57:43
RT @muathe: [VIDEO] Weekend Market Analysis 08/23/2014 [PUBLIC] $PFB $BAC $TWTR $GE $AAPL $PFE $MSFT $ES_F $FB $QQQ $CRM $SPY http://t.co/V…
Tommy The Trader
23 Aug 14 10:57:07
S&P 500 $SPY - Needs to rest a bit, quite a move…$AAPL $BIDU $NFLX stock charts http://t.co/xWO4MkEbls
Edward Gofsky
23 Aug 14 10:56:45
RT @chessNwine: I analyzed $BAC $PCLN $XLF and much more in my video market recap from earlier: http://t.co/UdJUCBSgI4 $SPY $STUDY
Edward Gofsky
23 Aug 14 10:55:54
RT @alphatrends: VIDEO http://t.co/EMOvI7LovA Stock Market Analysis For Wk Ending 8/22/14 $SPY $QQQ $IWM $XLF $GLD $AAPL $TWTR $AAPL #tradi…
Stock Headlines
23 Aug 14 10:47:34
$SPY: STOCKS FINISH MIXED AFTER YELLEN SPEAKS: Here's What You Need To Know http://t.co/NjpUITHEKa http://t.co/oIyDhfBdHE
Alfred Ip
23 Aug 14 10:43:53
some decent trade ideas from last week ex crm ER Bearish Chart Setups: $DATA $FEYE $LVS $MPEL $CRM $SPY http://t.co/aix60Y1I8o
Alfred Ip
23 Aug 14 10:42:54
some nice trade ideas from last week Bullish chart set ups: $GWPH $ILMN $WDAY $CELG $BKW $SPY $SOHU $TWTR $SINA $VNET http://t.co/Kv72ZQ3NTU
MarketSwingPlayer
23 Aug 14 10:41:57
Up, up and away she went from long signal on the DAILY. Did you get your long on? Supt/res $SPY http://t.co/ey3lfkOUHy
				
				
By  +Follow January 21, 2014 9:00AM
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