Exchange Traded Funds (ETFs) have become the investment vehicle of choice for many investors seeking a low cost and tax efficient approach to putting their investment dollars to work. Building on the concept and launch of a passive, end-of-day approach to track a broad market index by the late John (Jack) Bogle of Vanguard fame in 1976, advancements in faster and more powerful computing power enabled the development and introduction of the ETF structure. Rather than making or exiting an investment using end-of-day fund pricing, an ETF trades like an individual stock. This provides an investor the ability to trade throughout the day or employ other techniques such as placing a “limit order” to buy or sell the ETF at a specific price, either as a day order or what’s known as “good ‘til cancelled” order, something unavailable if using the traditional open-ended mutual fund structure.
Many investors are well aware of various U.S. index specific or “total market”/“broad market” related ETFs. But did you know that the first ETF tracking a specific stock market index was launched by our Canadian neighbors to track their Toronto 35 Index in 1990? It wasn’t until 1993 that the well-known SPDR S&P 500 Index™ ETF came on the market. According to ETF.com, there are nearly 4,800 ETFs holding an estimated US$10+ Trillion. Vanguard’s S&P500™ ETF now heads the list, recently surpassing the US$700Billion mark, besting the assets held by the original SPDR S&P 500™ issue.
While not nearly as popular as equity ETFs, the first four bond related ETFs made their debut in 2002: three U.S. Treasury and 1 U.S. corporate related issues. Recent estimates by Y-Charts and ETF.com put the number of various themed bond ETFs at somewhere between 835 to 950 issues, respectively, holding roughly US$2Trillion. Categories would include U.S. Treasuries, Municipals, investment grade corporates, and high-yield -aka-“junk”, among others.
As is typical of Wall Street, a concept creating a simplistic, investor friendly investment instrument, rapidly morphed into a plethora of more complicated and narrowly focused products. Single country-specific ETFs were introduced in 1996, followed by sector specific ETFs in 1998, enabling investors to target their favorite country or focus on their favorite sector, or whatever sector they thought would outperform the others. Leveraged ETFs, those structured to magnify gains or losses by 2x or 3x on a daily basis, emerged in 2006, catering to day traders and institutional types. It took a while, but it’s no surprise that similarly leveraged single stock ETFs finally hit the market in 2022. In our opinion, these are pretty dicey instruments, better suited for the casino gambling minded speculator and having similar outcomes: the house usually wins, not the gambler! Crypto and cannabis related ETFs are also available for those so inclined to indulge!
We generally stick to using a plain vanilla, unleveraged index fund or “broad/total market” fund and avoid the sector ETFs. We have a different take that “ETF” really means “Examine The Fund” —as in fund holdings and weightings. We’ve found that many of the sector related ETFs have a high percentage weighting in 5 or less specific issues. In other words, the fund may not be well diversified and returns may be more heavily dependent on just a few key fund holdings.
A great example of this is a well-known energy ETF which is often recommended by financial TV pundits and others as “what to own” if an investor wants exposure to the oil and gas sector. Problem is, in our opinion, that of the top 10 positions, just 2 names account for nearly 40% of the ETF’s holdings (the #1 position being nearly 23%!). The remaining 8 account for roughly 35% of the fund. Ten holdings comprising 75% of the ETF does not strike us as being very well diversified and we suspect it’d be hard for the ETF’s remaining 25% to move the return needle much either way.
A similar situation exists for a popular technology ETF from the same issuer. In this case, of the top 10 holdings, 3 positions comprise roughly 42% of the fund with the remaining 7 making up ~22%. As with the energy ETF, this top-heavy concentration with 10 positions accounting for roughly two-thirds of the fund does not seem diversified to us.
The bottom line here is to be sure to read the label of investment “ingredients” to know what you’re investing in!
For more information: https://www.etf.com, Exchange-traded fund – Wikipedia
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