Over the past few decades, exchange-traded funds (ETFs) have taken the investing world by storm.
These once-obscure pooled investment vehicles can now be found in portfolios around the world, from the largest firms to the most modest private investors. By collecting many stocks, bonds or other assets into a single fund, ETFs make it easy and efficient to diversify an investment portfolio.
But how did the popularity of ETFs soar to such great heights? And how did they come about to begin with?
Let’s go back in time and see how it all began.
The Evolution of ETFs
The First Pooled Investment Vehicles
ETFs may be a fairly recent invention, but the concept of bundling many different assets into one package is far from new.
In 1924, the Massachusetts Investors Trust (MITTX) was created, purporting itself to be “the world’s first open-end investment fund” — in other words, the first mutual fund with redeemable shares.
Investors could pool their money into the trust, whose professional managers would then invest it into a variety of stocks on their behalf. Any earnings would be split proportionately among the investors, who were happy to offload the tedium of portfolio maintenance onto the trust.
The Rise and Fall of the MITTX
The fund advertised itself through brokerage channels, attracting enough interest to debut with $50,000 in capital — in today’s money, that’s approximately $806,000. That original $50,000 in assets grew to $14 million within just five years.
The prosperity wouldn’t last, though: after the stock market crashed in 1929, the fund lost 83% of its value. It would several decades before mutual funds — and the rest of the investing world — would recover.
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But in the 1960s, Fidelity Investments started offering mutual funds to the general public, which loved the idea of such a simple yet diverse investment vehicle. This new popularity would be the catalyst for another innovation: index funds.
Introducing Index Funds
Before 1975, stock market indices were useful for getting an overview of the market, but synchronizing your portfolio with them was arduous.
John C. Bogle, founder of Vanguard, had a radical solution to that problem: create a fund that tracked the S&P 500 index. It would be a more passive form of investing that mirrored the market rather than trying to beat it — and thus, the first index mutual fund was born.
Bogle expected the Vanguard Group’s First Index Investment Trust to attract $150 million in initial investments. But on December 31, 1975, the fund debuted with just $11.3 million in assets, angering investors and earning it the nickname “Bogle’s Folly”.
A Rough Beginning — and a Redemption Arc
But the fund persisted through its rocky start, and the bull market of the ’80s and ’90s attracted millions of new investors to the world of index funds. People saw the stock market booming, and these interesting new funds made it dead simple to claim a share of it.
However, index mutual funds were still limited: they couldn’t be traded on exchanges at will, only bought or sold after trading closed for the day. Many investors, especially small businesses and active individual traders, were clamoring for a more liquid index investment vehicle.
Luckily for them, the introduction of electronic trading in the ’80s would pave the way for the very thing they desired: the exchange-traded fund.
ETFs Take Center Stage
Before ETFs truly took off, the concept of an exchange-traded index fund had a bit of a false start.
In 1989, Index Participation Shares (IPS) made headlines as the first S&P proxy to be traded on the stock exchange. But because the investments held the index itself rather than the actual stocks, it was classified as a futures contract and forced off the stock exchange.
Its replacement came in January 1993: Standard & Poor’s Depository Receipts (SPDRs), known colloquially as “Spiders”. The SPDR SPY, which tracked the S&P 500 and traded under the symbol SPY, was the first true ETF — a way for anyone to purchase an index fund on the stock exchange.
SPDRs and Diamonds and WEBS, Oh My!
The SPDR SPY was hugely popular, with total returns of over 38% in 1995. This kickstarted an ETF boom, with the biggest names in finance all vying for a piece of the pie.
In 1996, Barclays debuted its World Equity Benchmark Shares, or WEBS, which bundled 17 country indices and gave ordinary investors an easy way to add foreign markets to their portfolios.
And in 1998, the Dow Diamonds became the first ETF to track the Dow Jones Industrial Average. The NASDAQ-100 index got its ETF in 1999 in the form of the QQQ, also known as the “cubes”.
2001 saw Vanguard try its hand at ETFs, introducing the Vanguard Total Stock Market ETF. As its name suggests, it included every publicly-traded stock in the U.S.
ETFs Go Beyond Stocks
By 2002, just 9 years after the SPDR’s genesis, there were 102 ETFs on the market. It was time for ETFs themselves to diversify beyond stocks and into other asset classes.
2002 marked the debut of the iShares IBoxx $ Invest Grade Corp Bond Fund, which collected a variety of corporate bonds into one ETF. This simplified the process of bond trading, opening it up to more casual investors by making it as easy as trading stocks.
In 2004, the SPDR Gold Trust became the U.S.’s first commodity ETF, trading gold bullion under the symbol GLD. That same year, total U.S. ETF assets totaled $228 billion.
And in 2008, ETFs got the green light from the SEC to go beyond passive investing: they were now permitted to be actively managed. This allowed for creative new ETFs that combined multiple asset classes, such as the Bear Stearns Current Yield ETF, which tracks various stock indices as well as commodities like gold, crude oil and even sugar.
ETFs Today: Facts and Figures
Today, there are 8,552 ETFs around the world, with assets totaling over $10 trillion USD. 74% of these assets are managed in North America, with a value of $7.19 trillion spread across 2,632 ETFs.
By far the largest American ETF brand is iShares, whose assets across all ETFs total over $2.3 trillion — nearly a third of all North American ETF assets.
78% of U.S. institutional investors consider ETFs their go-to investment vehicle, and that number is only expected to grow. It’s no wonder that global ETF assets are expected to top $12 trillion by the end of 2023.
And with new technologies like cryptocurrency and AI taking hold, the future of ETFs looks to be a truly exciting one. One thing’s for sure: this once-outrageous investment is now an integral part of our economy.