Many people equate exchange-traded funds (ETFs) with index products. They are, however, not the same thing.
Not all ETFs track an index, and not all index funds are ETFs. There are many unit trusts around the world that are passively managed, and in some parts of the world there are now ETFs with actively managed portfolios.
And while there is no question that the rise of passive investing has been the most important development in the asset management industry over the past 20 years, ETFs as a concept on their own have also changed the landscape significantly.
Changing the world
Alex Matturri, outgoing CEO of S&P Dow Jones Indices, believes ETFs have been “the most disruptive concept in financial history in many ways”. Matturri announced last year that he will be retiring in 2020, and in reflecting on the developments he has seen during his career, this, he says, is the most significant.
“Indexing has been around for a while – well before ETFs – but it was the creation of the ETF that gave everybody access to financial exposures that they couldn’t get before, in a product category where everybody paid the same price,” Matturri points out.
“The biggest institution and the smallest retail investor can now all pay the same to get access to the same product.”
This had never been the case before. Investment products were traditionally priced on how much you have to put into them. Large institutions paid less because they had significantly more assets, and individuals were required to pay more.
But because an ETF is traded on an exchange, like shares in a company, there is no distinction between the types of investors using them.
Something for everyone
“ETFs also brought flexibility to creating products that gave people transparent, low-cost investment options that allowed them to do things like save for retirement,” Matturri adds. “Indexing is what drove it, but it’s really the ETF wrapper that was the game-changer in my mind.”
It is also notable how ETFs are being used in a wide range of ways across the world.
“In India the government is using an ETF structure to divest ownership of public companies,” Matturri says. “In Japan, you have the government using ETFs as part of their quantitative easing. In Hong Kong the government supported the Hong Kong dollar years ago by buying up a number of companies on the exchange. They got rid of those holdings by creating an ETF structure.”
Nobody thought of these as possible uses when ETFs were first created.
This makes Matturri believe that there will be many uses for ETFs in the future that the market hasn’t considered yet, and which will probably result in further disruption.
“That’s really earth-shattering,” says Matturri. “You just have to see how ETFs in combination with the growth of indexing is changing the active management business. It’s really disrupted that business model, and that still has a long way to go in terms of mispricing of services.”
Matturri argues that you could even equate ETFs to mobile phones in some ways. They are an innovation that allows people in certain markets to ‘leapfrog’ to the same level of sophistication as their counterparts in more developed markets without having to use legacy products to get there.
“One thing I’ve always been fascinated by is how newer markets adopt newer technologies faster,” he says.
“If you think of how long it took the US, which had more of an equity culture, to move into indexing and ETFs, you’ve seen a much faster adoption in other markets.”
Read: War of the worlds
In South Africa, for example, the size of the passive market is still relatively small, although it is growing meaningfully. However the products available here, such as smart beta and multi-factor offerings, are as sophisticated and well-constructed as anything anywhere else in the world.
“Newer markets sometimes jump the queue like this, much like you hear that India doesn’t have landlines, but everybody has the best cell phone systems,” says Matturri.
“It’s the same with investment products, that you will see some of the newer markets, like China or India, adopting things faster than they have been in more developed markets.”
They are able to do so because they can learn from what has already been tried elsewhere.
“So you could have some markets where ETFs grow as quickly as investing in general grows,” Matturri suggests. “You’ve seen it in some markets where the first products coming to market are ETFs. In India, where the government is trying to spur investing and create an investment culture, part of the way they are doing it [is in] trying to get people to use ETFs as a vehicle.
“I believe these kinds of markets will develop in a shorter life cycle, even though they are coming from a lower base today.”