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What is an ETF?

By  +Follow December 26, 2014 7:00AM
Tickers Mentioned:

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
Stock Market Outlook
2 Jul 15 09:35:41
The Dow Divergence Is A Good Thing http://t.co/Pes60bvAMH $AA $BAC $CSCO $FEYE $GS $HPQ $NDAQ $NKE $SPY $T $V $AAPL $DIA
Seeking Alpha
2 Jul 15 09:35:41
The Dow Divergence Is A Good Thing http://t.co/bf9OTbSHhM $AA $BAC $CSCO $FEYE $GS $HPQ $NDAQ $NKE $SPY $T $V $AAPL $DIA
2 Jul 15 09:33:33
$UFAB Unique Fabricating, Inc. to Ring NYSE Closing Bell on Monday, July 6, 2015 http://t.co/IuJW8wOk7S $SPY $DIA $QQQ $AAPL $GM $F $BAC
Stock Trade Alerts
2 Jul 15 09:33:05
RT @zozotrader: $SPY 5 min chart http://t.co/1reorAbZmI down at 200 sma
alfredo vinci
2 Jul 15 09:33:01
RT @SeekingAlpha: Gilead Sciences- A Rare Undervalued Company In A Frothy Biotech Market http://t.co/yeYozu4yKL $IBB $SPY $GILD
Shiny Grabber
2 Jul 15 09:31:57
All other instances of 8+ consecutive days $SPY closed lower than its open, & a look at the 2 months following. http://t.co/DZScs06hb8
Love Salsa
2 Jul 15 09:30:47
$SPY 206.80 area has all kinds of support. If we make it that low, at least a small bounce could show up. Will take effort to break.
Portfolio Talk
2 Jul 15 09:30:33
Shocking Proof that "Good" Investments Sometimes Start Out Bad via @IBKR http://t.co/0MC0uP1ix8 $AAPL $AMGN $SPY
Half Full Publishing
2 Jul 15 09:30:33
Shocking Proof that "Good" Investments Sometimes Start Out Bad via @IBKR http://t.co/Swy8a8YlkG $AAPL $AMGN $SPY
Ron DeLegge
2 Jul 15 09:30:31
Shocking Proof that "Good" Investments Sometimes Start Out Bad via @IBKR http://t.co/yguvp9nGW3 $AAPL $AMGN $SPY
Gents With No Cents
2 Jul 15 09:30:12
Shocking Proof that "Good" Investments Sometimes Start Out Bad via @IBKR http://t.co/Nmoh6ypUhR $AAPL $AMGN $SPY
Volodymyr S
2 Jul 15 09:30:06
If $SPY would be up nicely i would consider shorting $TSLA here around $277 with 1 point stop, but with SPY down, hard to judge. i pass
2 Jul 15 09:29:39
vol surge, perfect bear bar so hopefully the rebound this time could go a little far $SPY $SPX $ES_F http://t.co/I7cXWn3BYi
2 Jul 15 09:29:05
$SPY 5 min chart http://t.co/1reorAbZmI down at 200 sma
Andre Arsenault
2 Jul 15 09:29:01
RT @Jacob_Mintz: Greek/Puerto Rico/China concerns. May be time for a hedge. My article on how to hedge a portfolio $SPY $GREK $AAPL http:…
Trade Forex Signals
2 Jul 15 09:28:43
It looks closer to 204 than 213 $SPY http://t.co/tbfpB9VkUV ~ via http://t.co/Kd2qwcsyit
Wall Street Forecast
2 Jul 15 09:27:35
$ES_F $SPY -- Target of 64.5 hit. 2-point gain http://t.co/FeHyO2Hadh
2 Jul 15 09:27:24
$spy "looks" like it wants to go below 200 day
FMD Capital
2 Jul 15 09:27:22
$SPY was nearly unchanged in the first half of 2015, yet the divergences in underlying sectors told a different tale http://t.co/d06eo5DHVx
2 Jul 15 09:27:06
"Trend is your friend" - theme for the past few days $SPY
TV_Trading Ideas
2 Jul 15 09:26:08
It looks closer to 204 than 213 $SPY http://t.co/JfS2qKIu5C
David Moadel
2 Jul 15 09:25:54
$SPY falling and having no effect on my $XLU ... I am enjoying this
Dan Zwicker
2 Jul 15 09:25:40
RT @itracspy: #ITRAC S&P 500 Forecast for July 2nd, 2015. http://t.co/sUfaFVHFRo $SPY $SPX #LONG http://t.co/NktlBSCry6
James DiPlata
2 Jul 15 09:25:31
RT @Options_CAT: Latest pre-jobs article for $SPY bear #optionstrading idea. http://t.co/vhT6I5Swna
Ian Fischler
2 Jul 15 09:24:42
RT @RyanDetrick: Looking for a reason to be bullish? 8-wk MA of AAII bulls is still near '09 lows. I find that very encouraging. $SPY http…
$$ D.J. NIEMIEC $$©
2 Jul 15 09:24:26
Just sold $SPY Calls for a loss $SPY http://t.co/DtuhQrJlJM
Stephanie Collins
2 Jul 15 09:24:11
RT @itracspy: #ITRAC S&P 500 Forecast for July 2nd, 2015. http://t.co/sUfaFVHFRo $SPY $SPX #LONG http://t.co/NktlBSCry6
$$ D.J. NIEMIEC $$©
2 Jul 15 09:24:00
Just sold $SPY Calls for a loss $SPY http://t.co/zwejzjRtsE
2 Jul 15 09:23:35
Swing #Trading Long $ORCL on support level & oversold condition $SPY $QQQ http://t.co/qMQltPJbk8
2 Jul 15 09:22:56
RT @OptiontradinIQ: A bad sign for an uptrend is when price starts to gap up at the open and finish lower on the day. $SPY
Stock Trade Alerts
2 Jul 15 09:21:34
BLOCK TRADE: $SPY 501,297 shares @ $207.49 [12:20:43]
Stock Trade Alerts
2 Jul 15 09:21:32
BLOCK TRADE: $SPY 520,000 shares @ $207.21 [12:19:36]
2 Jul 15 09:20:44
BLOCK TRADE: $SPY 501,297 shares @ $207.49 [12:20:43]
Danan Kirby
2 Jul 15 09:20:32
The $VIX implied a much larger move in $SPY than what occurred based on regressions. $STUDY #Grexit http://t.co/WjdyQ7m2Av
Meritocracy Capital
2 Jul 15 09:20:15
SMART MONEY SELLING $SPY $DJIA #nyse #NASDAQ $tsx Read more here ---> http://t.co/nHLmWOgeIZ http://t.co/SNYwlFjuSN
Justin Pulitzer
2 Jul 15 09:20:11
@travelingcoolie @thechartress I'm looking at doing some. I have some in $SPY already… but has to be a small net credit IMHO.
2 Jul 15 09:19:37
BLOCK TRADE: $SPY 520,000 shares @ $207.21 [12:19:36]
George Tkaczuk
2 Jul 15 09:19:23
RT @RyanDetrick: Looking for a reason to be bullish? 8-wk MA of AAII bulls is still near '09 lows. I find that very encouraging. $SPY http…
Large Void
2 Jul 15 09:17:58
$SPY bear flag up to 209, then drop to 202... then drop to 196. we'll see after that (20% pullback)
2 Jul 15 09:17:01
$SPY about to crack
Tristan MArroquin
2 Jul 15 09:17:00
$es_F $SPX $SPY about to turn. Look at the $RUT $IWM guys. Don't get to short.
Sylvain Asimus
2 Jul 15 09:16:29
S&P500 #futures do not fill gap, stay vulnerable $SPX $SPY https://t.co/QDvRGsvSIS http://t.co/wHgpEEniaA
2 Jul 15 09:16:11
2 Jul 15 09:15:35
RT @Jacob_Mintz: Greek/Puerto Rico/China concerns. May be time for a hedge. My article on how to hedge a portfolio $SPY $GREK $AAPL http:…
2 Jul 15 09:15:29
2 Jul 15 09:11:16
when I said I was going to trade $SPY all summer i meant it. You can make money everyday trading this thing http://t.co/m8uafOWPR9
SMPH #Sanders2016
2 Jul 15 09:10:48
$VRTX active, relative volume: 18.38, 1H, 12:00 PM, #nasdaq $NDX $SPY http://t.co/mWqUw11a7O
SMPH #Sanders2016
2 Jul 15 09:10:47
$NVDA active, relative volume: 124.48, 1H, 12:00 PM, #nasdaq $NDX $SPY http://t.co/mWqUw11a7O
SMPH #Sanders2016
2 Jul 15 09:10:47
$DD active, relative volume: 6.0, 1H, 12:00 PM, #nasdaq $SPY $DJI http://t.co/mWqUw11a7O
Michael Hurt
2 Jul 15 09:10:44
RT @Couzin_Vinny: $SPY 15 min watching for higher low (>206.56) yet again to continue trend change move higher http://t.co/BM161cJyH9
By  +Follow December 26, 2014 7:00AM



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