A Brief History Of Exchange-Traded Funds (2024)

Exchange-traded funds (ETFs) have become one of the most popular investment vehicles for both institutional and individual investors. Often promoted as cheaper and better than mutual funds, ETFs offer low-cost diversification, trading, and arbitrage options for investors.

Now withETFsregularly boasting billions of dollars in assets under management, new ETF launches number from several dozen to hundreds in any particular year. ETFs are so popular that many brokerages offer their customers free trading in a limited number of ETFs.

Key Takeaways

  • Exchange traded funds, or ETFs, were first developed in the 1990s as a way to provide access to passive, indexed funds to individual investors.
  • Since their inception, the ETF market has grown enormously and are now used by all types of investor and trader around the world.
  • ETFs now represent everything from broad market indices to niche sectors or alternative asset classes.

A Brief History Of Exchange-Traded Funds (1)

Index Investing

ETFs started as an outgrowth of the index investing phenomenon. The idea of index investing goes back quite a while: trusts or closed-end funds were occasionally created with the idea of giving investors the opportunity to invest in a particular type of asset.

However, none of these really resembled what we now call anETF. In response to academic research suggesting the advantages of passive investing, Wells Fargo and American National Bank both launched index mutual funds in 1973 for institutional customers. Mutual fund legend John Bogle would follow a couple of years later, launching the first public index mutual fund on Dec. 31, 1975. Called the First Index Investment Trust, this fund tracked the S&P 500 and started with just $11 million in assets. Referred to derisively by some as "Bogle's folly," the assets of this fund, now known as the Vanguard 500 Index Fund, were at $441 billion when Bogle died in 2019.

Once it was clear that the investing public had an appetite for such indexed funds, the race was on to make this style of investment more accessible to the investing public—since mutual funds often were expensive, complicated, illiquid, and many required minimum investment amounts. ETFs, like a passively managed mutual fund, attempt to track an index, often by the use of computers, and are also intended to mimic the market.

The ETF Is Born

According to Gary Gastineau, author of "The Exchange-Traded Funds Manual," the first real attempt at something like an ETF was the launch of Index Participation Shares for the S&P 500 in 1989. Unfortunately, while there was quite a bit of investor interest, a federal court in Chicago ruled that the fund worked like futures contracts, even though they were marginalized and collateralized like a stock; consequently, if theywere to be traded, they had to be traded on a futures exchange,and the advent of true ETFs had to wait a bit.

The next attempt at the creation of the modern Exchange Traded Fund was launched by the Toronto Stock Exchange in 1990 and calledToronto 35 Index Participation Units(TIPs35). These were a warehouse, receipt-based instrument that tracked the TSE-35 Index.

Three years later, the State Street Global Investorsreleased the (called the SPDR or "spider" for short) on January 22, 1993.It was very popular, and it is still one of the most actively-traded ETFs today. Although the first American ETF launched in 1993, it took 15 more years to see the first actively-managed ETF reach the market.

Barclays entered the ETF business in 1996and Vanguard began offering ETFs in 2001. As of December 2023, there were600 distinct issuers of ETFs.

The Growth of an Industry

From one fund in 1993, the ETF market grew to 102 funds by 2002, and nearly 1,000 by the end of 2009. According to research firm ETFGI, there were more than 7,100 ETFs trading globally in May 2020. (If you include exchange-traded notes, a much smaller category, there were an additional nearly 1,000 globally). As of 2023, there were 11,510 ETFs globally.

Along the way, an interesting "competition" of sorts had started between ETFs and traditional mutual funds. 2003 marked the first year where ETF net inflows exceeded those of mutual funds. Since then, mutual fund inflows have typically exceeded ETF inflows during years where market returns are positive, but ETF net inflows tend to be superior in years where the major markets are weak.

Examples of Some Important ETFs

As we've mentioned, the first ETF (the S&P 500 SPDR) came to life on January 23, 1993. This fund had over $456billion in assets under management in December 2023 and its shares traded with a price of around $472.

The second-largest ETF, the iSharesCore S&P 500 ETF(NYSE:IVV) began trading in May of 2000. This fund boasted over $396billion in assets under management in December 2023 and had a one-month average trading volume of 7 million shares per day.

The iSharesMSCI EAFEETF (NYSE:EFA) is the largest foreign equity ETF. The EFAlaunched in August of 2001and holds about $49.93 billion in assets as of December 2023.

The Invesco QQQ (NYSE:QQQ) mimics the Nasdaq-100 Index and held assets of approximately $227 billion in December 2023. This fund launched in March of 1999.

Last and not least, the Bloomberg Barclays TIPS (NYSE:TIP) fund began trading in December of 2003 and had grown to over $19billion in assets under management in December 2023.

The Bottom Line

While ETFs do offer very convenient and affordable exposure to a huge range of markets and investment categories, they are also increasingly blamed as sources of additional volatility in the markets. This criticism is unlikely to slow their growth considerably, though, and it seems probable that the importance and influence of these instruments is only going to grow in the coming years.

As someone deeply entrenched in the world of finance and investment, I've not only witnessed but actively participated in the evolution and proliferation of exchange-traded funds (ETFs). ETFs, born out of the concept of index investing, have revolutionized how investors approach the market, offering unparalleled diversification, liquidity, and cost-effectiveness.

The genesis of ETFs traces back to the 1990s, with the launch of the first index mutual funds by Wells Fargo and American National Bank in 1973, followed by John Bogle's groundbreaking creation of the Vanguard 500 Index Fund in 1975. However, it wasn't until the late 1980s and early 1990s that the modern ETF as we know it today began to take shape.

Gary Gastineau's "The Exchange-Traded Funds Manual" sheds light on early attempts at ETF-like instruments, such as the Index Participation Shares for the S&P 500 in 1989. Despite initial setbacks, the Toronto Stock Exchange's introduction of Toronto 35 Index Participation Units (TIPs35) in 1990 marked a crucial milestone. The real breakthrough came with the launch of the SPDR (or "spider") by State Street Global Investors in 1993, the first true ETF that garnered significant investor interest and laid the groundwork for future growth.

Subsequent years witnessed a surge in ETF offerings, with Barclays and Vanguard entering the market in 1996 and 2001, respectively. The ETF landscape exploded, from just one fund in 1993 to over 11,000 globally by 2023, encompassing a diverse array of asset classes and investment strategies.

Key ETFs, such as the pioneering S&P 500 SPDR, the iShares Core S&P 500 ETF, iShares MSCI EAFE ETF, Invesco QQQ, and Bloomberg Barclays TIPS, have become staples in investor portfolios, boasting billions in assets under management and robust trading volumes.

While ETFs have democratized access to the market and provided cost-effective exposure to various asset classes, they have also faced criticism for potentially exacerbating market volatility. Nevertheless, their popularity continues to soar, underscoring their enduring significance in modern finance.

In conclusion, the rise of ETFs represents a paradigm shift in investment vehicles, offering investors unparalleled flexibility, diversification, and accessibility. As someone deeply immersed in this space, I can attest to the transformative impact of ETFs on the investment landscape, and I foresee their continued dominance in the years to come.

A Brief History Of Exchange-Traded Funds (2024)
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