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The most disruptive concept in financial history

The humble ETF.
ETFs allow people in certain markets to 'leapfrog' to the same level of sophistication as those in more developed markets. Image: Shutterstock

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.

Read: SA’s exchange-traded product market passes R100bn

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.

Read: The top-performing exchange-traded products of 2019

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.”

Getting ahead

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.”

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COMMENTS   9

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Yawn. Making sound, rational investment decisions requires knowing ALL of the facts about a particular investment vehicle, and ETFs are no different. Inherent risks of ETFs are numerous – lack of liquidity, trading fees, risk due to underlying volatility, paying a premium for a share in the index composition, performance expectations – to name but a few. Instead, the perceived popularity of ETFs in South Africa are based on the consequence of shrinking investment time horizons, investing with emotion, the noise of poor, voluminous news flow and the fixation that lower costs means better value. All wealth destroying, critical mistakes. Caveat emptor!

And your superior alternative is…?

Would love to hear your alternative?

In a low return environment the only way to improve your return is to reduce costs. One way to reduce costs is to take asset managers fees/ performance fees out of the equation. Active managers may be become obsolete in the future as the value they add rarely exceeds the cost the add.

ETF’s disruptive?

I think the answer to that question is crypto.

I’m definitely agreeing with MichaelfromKlerksdorp here !

Was going to post that comment myself

Already the average weighting of BTC and alt currencies are up a mean +-30% this year, thanks you [ stay with the blue chips, ie BTC,LTC, XRP,Cardano and Monero ]

Smiling very nicely this side

But thats not why I got massively into crypto

Its because NO bankster/SARS/greedy corrupt politician/creditor/mother-in-law etc CAN TOUCH MY MONEY !

And I can send it to family and friends anywhere in the world in 20 minutes, and they can cash out that side

No questions asked……no paperwork to fill in……immediate !

Plus, its held in $, which is a nice hedge….so as the ZAR weakens, you get the double windfall [ growth in crypto, and the Zar/$ exchange ]

And rock solid safe

Thank you Satoshi, whoever you/them may be !!!!!

You get my vote! The reality is in the ‘bytes’ 😉

Was about to ask you which cryptos you prefer (out of a plethora), but I see you answered that one already. Just keep it secure from hackers (still edgy about cyber security from some exchanges)

But I suppose, if a hacker really wants to, your online banking can also be hacked. The best safety is between the ears of the user.

MichaelfromKlerksdorp wrote

“But I suppose, if a hacker really wants to, your online banking can also be hacked. The best safety is between the ears of the user.”

Exactly…firstly, looking after your money is a common sense approach, whether its old school cash/online bank acc or crypto

Any carelessness is going to have a bad result – whether leaving your cash wallet lying on a bar counter, or handing over online bank details to a hacker etc

Same with crypto – if you going to be careless, you going to lose

So, hold the large amounts of crypto in cold storage [ BTC/Litecoin etc ]

Small amounts keep on the exchange for small transactions

And, you good to go !

Ahem, let me get this straight. ETF’s have R100 bn under management. Total assets in SA investments markets around R7 trillion rand. That is 1,4% of the total.
“Changed the investment landscape significantly”. I suggest not. Some single unit trust funds have more than that under management.
I suggest the article reeks of marketing over-reach. Some context is required.

End of comments.

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