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What is an ETF?

By  +Follow December 26, 2014 7:00AM
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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. To read our full disclosure, please go to: http://www.equities.com/disclaimer


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Results for SPY
Kunal Desai
27 Aug 15 18:28:13
Trading Watch List 08.28.2015 - http://t.co/1agGbtdP8x $spy $qqq $tree $tsla $mbly $tree $amba $nflx
Bulls On Wall Street
27 Aug 15 18:28:11
Trading Watch List 08.28.2015 - http://t.co/OahvOXdxOI $spy $qqq $tree $tsla $mbly $tree $amba $nflx
Stocky Trader
27 Aug 15 18:27:34
$SPY $ES.F Take the positives out of any situation. The volume pick up has been beaut. Summer trading has been LOW V. http://t.co/2NERJmtEEc
LHommeAncien
27 Aug 15 18:26:54
sorry Rudy but that's just how quantum physics works....it's uphill in every direction $spy https://t.co/U9EIwfjiEm
Joe McCann
27 Aug 15 18:26:52
RT @StockTwits: In two days the Dow is up 988 POINTS. The S&P 500 is up 120. That's the biggest two-day rally since 2009: http://t.co/sESc…
Fahad Khalid
27 Aug 15 18:26:27
First thing on Monday morning when everyone was panicking: Bought $DIA at $155, sold puts under $DIA and sold puts under $SPY
Rededdy
27 Aug 15 18:26:27
RT @gtlackey: Would be a V-ehemoth rally if it runs from here. not the highest probability, but sure would catch many off guard if so $QQQ …
Denny
27 Aug 15 18:26:15
RT @seeitmarket: Fed Watch: Is QE4 A Possibility? http://t.co/7dHWSmXbIu by @hedgopia $SPY #FED http://t.co/ysRxg3qErd
LHommeAncien
27 Aug 15 18:25:51
you gotta luv the precision and stupidity of this kind of forecast $spy https://t.co/ot5xP84Wfv
Steve
27 Aug 15 18:25:27
RT @StateDave: Am I the only one that thinks Goldman/Virtu/Citadel/Getco REALLY want that "Dow up 500" headline today? $DIA $SPY
TradingTricks
27 Aug 15 18:25:27
RT @seeitmarket: New Post - "Trading ETFs In Uncertain Markets: Patience and Process" http://t.co/MbQ9LOP5cA by @fabiancapital $SPY $VIX $S…
Simon Constable
27 Aug 15 18:25:25
RT @ETFFunds: Was Monday's Market Plunge A Mega-Capitulation? Nah!.. http://t.co/zKLgvr6RtF $SPY #ETF #ETFs #Stocks
Stocks & Trades
27 Aug 15 18:24:53
RT @StockTwits: In two days the Dow is up 988 POINTS. The S&P 500 is up 120. That's the biggest two-day rally since 2009: http://t.co/sESc…
Ez3Xu!eL
27 Aug 15 18:24:51
RT @StockTwits: In two days the Dow is up 988 POINTS. The S&P 500 is up 120. That's the biggest two-day rally since 2009: http://t.co/sESc…
Michael Licari, Esq.
27 Aug 15 18:24:44
RT @StockTwits: In two days the Dow is up 988 POINTS. The S&P 500 is up 120. That's the biggest two-day rally since 2009: http://t.co/sESc…
Ichimoku Charts
27 Aug 15 18:24:06
Buyers continue to build momentum FREE S&P500 Stock Market Review Aug27 http://t.co/TrYibg1Iem $SPY $SPX #stocks $$ http://t.co/Lo0LbEji9Q
Scott A Rogers
27 Aug 15 18:23:56
RT @StockTwits: In two days the Dow is up 988 POINTS. The S&P 500 is up 120. That's the biggest two-day rally since 2009: http://t.co/sESc…
Girish Vaidya
27 Aug 15 18:23:22
RT @StockTwits: In two days the Dow is up 988 POINTS. The S&P 500 is up 120. That's the biggest two-day rally since 2009: http://t.co/sESc…
Kiliam
27 Aug 15 18:23:06
@mikemoffet hope you profit from the alerts. $GLD $SLV $FCX $UGA $SPY all nicely in the money from the levels tweeted earlier.
CloudCharts
27 Aug 15 18:22:58
Buyers continue to build momentum FREE S&P500 Stock Market Review Aug27 http://t.co/niEZoJxxeV $SPY $SPX #stocks $$ http://t.co/w52zN0kEsg
FXTrader Hub
27 Aug 15 18:22:58
Buyers continue to build momentum FREE S&P500 Stock Market Review Aug27 http://t.co/ztOPGOrdK5 $SPY $SPX #stocks $$ http://t.co/IkG7vcEsAY
Larry Lovrencic
27 Aug 15 18:22:58
Buyers continue to build momentum FREE S&P500 Stock Market Review Aug27 http://t.co/66OHvXpqSv $SPY $SPX #stocks $$ http://t.co/93sRRIcN6s
Simon
27 Aug 15 18:22:52
RT @StockTwits: In two days the Dow is up 988 POINTS. The S&P 500 is up 120. That's the biggest two-day rally since 2009: http://t.co/sESc…
Varun
27 Aug 15 18:22:18
RT @StockTwits: In two days the Dow is up 988 POINTS. The S&P 500 is up 120. That's the biggest two-day rally since 2009: http://t.co/sESc…
Stephen Ricciardi
27 Aug 15 18:21:39
RT @StockTwits: In two days the Dow is up 988 POINTS. The S&P 500 is up 120. That's the biggest two-day rally since 2009: http://t.co/sESc…
Jay Jay
27 Aug 15 18:21:38
"@jonmudry $AAPL $DIS $FB $AMZN $GOOG $TSLA $SPY $DJIA $NDAQ I think tomorrow is a day we cool off. We've gone up ~6% in two days."
Real Carl Icahn
27 Aug 15 18:21:13
RT @StockTwits: In two days the Dow is up 988 POINTS. The S&P 500 is up 120. That's the biggest two-day rally since 2009: http://t.co/sESc…
Ryan Alsup
27 Aug 15 18:20:51
RT @StockTwits: In two days the Dow is up 988 POINTS. The S&P 500 is up 120. That's the biggest two-day rally since 2009: http://t.co/sESc…
StockTwits
27 Aug 15 18:19:49
In two days the Dow is up 988 POINTS. The S&P 500 is up 120. That's the biggest two-day rally since 2009: http://t.co/sEScSKmFi0 $SPY $DIA
Steve Wakelin
27 Aug 15 18:19:17
RT @Eternity100000: $SPY L-H Aug 20 203.90 || 208.29 21 197.52 || 203.94 24 182.40 || 197.48 25 186.92 || 195.45 26 188.37 || 194.79 27 195…
LHommeAncien
27 Aug 15 18:17:50
good looking doesnt hurt either and rich....very very very rich $spy https://t.co/MhzoUCcpAt
Brian Shannon
27 Aug 15 18:17:02
RT @howardlindzon: New Blog Post - 'Markets in Turmoil are Opportunities ...and writing (journalling) works' http://t.co/oHghZsWNYU $xiv $s…
Eamonn Byrnes
27 Aug 15 18:13:02
RT @StockTwits: We just found the best meme you'll see this week. Thank you: http://t.co/fumdQypA5L $SPY $DIA $IWM http://t.co/UaAEYl94Hl
Real Carl Icahn
27 Aug 15 18:11:33
RT @RyanDetrick: NEW POST: Up For The Week, Who Saw That Coming On Monday Morning? http://t.co/cFwE1i78kf via @YahooFinance $SPY $DIA $Q…
LHommeAncien
27 Aug 15 18:11:07
sex tape $spy https://t.co/4vBH1Bxu98
Dave Fry
27 Aug 15 18:10:43
$SPY $SPX $RUT $NDX $XLE $XLB $TLT $VIX $UUP $FXE $GLD $EFA $EEM $IEV Is The BEA Cooking The Books? http://t.co/f1ub9aP3OQ
Denise Angel
27 Aug 15 18:08:30
RT @warriornewsfeed: The Home Depot (HD) Stock | Solid Play On Real Estate Growth https://t.co/IUUCQDiVKi #HD #HomeDepot $SPY $VIX $IWM $QQQ
Denise Angel
27 Aug 15 18:08:24
RT @warriornewsfeed: Best Buy (BBY) Stock | Becoming a Better Buy https://t.co/vagA3jxXYT #BBY #BestBuy $SPY $VIX $IWM $QQQ
Denise Angel
27 Aug 15 18:08:17
RT @warriornewsfeed: Economic Calendar Watch List 8/27/2015 https://t.co/tKZKsVRdEJ $SPY $VIX $IWM $QQQ
Denise Angel
27 Aug 15 18:08:13
RT @warriornewsfeed: Morgan Stanley (MS) Stock | A Substantial Slide https://t.co/WBlGQdgbNv #MS $SPY $VIX $IWM $QQQ
WeeklyOptionsTrader
27 Aug 15 18:07:49
Check out our tweets this entire week. We pounded the table on BUYING during that sell-off! We are #1! http://t.co/cnDtaBRw5w $SPY $QQQ $FB
goldbug2009
27 Aug 15 18:07:44
RT @Nouf_wpt: $SPY $SPX poss flat in the making bullish traders may want to take some precautions now #elliottwave http://t.co/TAmil8uN6Z
LHommeAncien
27 Aug 15 18:07:08
if you tweet things like $/ES +50!! like you bought it +1 but never post a trade in real time, let me say it for all of us fuck off $spy
STEVE KOUDANIS
27 Aug 15 18:06:02
RT @OMillionaires: Don’t miss the next 1k drop on the DOW and subsequent bounce while on the Can - coming soon ~ $SPY $QQQ $DIA $AAPL http:…
LHommeAncien
27 Aug 15 18:05:14
oh shyt i forgot one of my FAVES!! @RudyHavenstein like forgetting my left nut luv ya Rudy!! smarts and laughs and razor edge $spy
Maralyn Burstein
27 Aug 15 18:05:10
RT @Lhommeancien: this is SMART! $spy https://t.co/uvgB8Pi0Jy
advisory GdC
27 Aug 15 18:04:29
RT @RyanDetrick: AAII bulls 8-week MA coming off lowest level since March 2003 and March 2009. $SPY http://t.co/Zn6B3aKibL
GuerillaStockTrading
27 Aug 15 18:04:03
S&P 500 Levels For Swing Traders $SPY $QQQ $IWM https://t.co/ndWC3769dl http://t.co/tFatJxfezm
LHommeAncien
27 Aug 15 18:03:07
this is SMART! $spy https://t.co/uvgB8Pi0Jy
Option Millionaires
27 Aug 15 18:01:47
@Proflayton99 unless one thinks we are in a recession, not sure how we duplicate 2008… for now at least ~ but think $SPY 180 possible
				
				
By  +Follow December 26, 2014 7:00AM
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