Real-Time Problem Solving
A quarter-century later, while there are now 5,000 ETFs that track specific industries, sectors, commodities and geographies, SPY remains the largest2 and most traded ETF.3 In fact, SPY trades 4.2 times more than Apple (AAPL), which is the largest security in the world by market cap.4 That volume, combined with the size of SPY’s assets, its liquidity and its resilience in varying marketing conditions, has been important in building portfolios for some of the world’s most sophisticated investors. Today, Jim is the chairman of State Street Global Advisors’ family of ETFs. He’s most proud of how ETFs continue to help investors in times of market turmoil.
One of the first tests of the ETF in choppy markets came in the wake of the 9/11 attacks, when the US stock exchanges were closed for six days — the first trading disruption of longer than four consecutive days in the last 50 years.5 When markets reopened on September 17, investors heavily sold off industries like the airlines that had been impacted. “That was an extremely uncertain time for the global markets and a scary time for investors,” says Dave LaValle, head of ETF Capital Markets in the US. But then, a funny thing happened: Market participants started using SPY’s price as an implied valuation for the constituents of the S&P 500, giving the market time to adjust and correct.
September 11, 2001, was the first but not the last time this happened. ETFs have added an incremental but essential source of liquidity to the market during a number of market closures, constituent trading suspensions, market dislocations, natural disasters and human errors, providing investors with a tool to dig out of problems in the market in real time.
A Platform for Innovation
Jim compares ETFs to the iPhone. “The iPhone platform was a significant invention, no doubt, but the real revolution has been all of the innovative ways people have found to harness the smartphone’s power in daily life. Similarly, not all innovation in the ETF space comes from providers. A lot of it is user driven — in this case, by investors.” He points to insurance companies using ETFs rather than bonds as investment vehicles for their general accounts, and financial advisers using ETFs for asset allocation and diversification planning, as well as a number of wealth management firms using ETFs to package their investment beliefs into outcome-oriented products for their clients.
Rather than being a threat to the traditional adviser, ETFs create a new model that gives advisers the ability to outsource the investment component, so that they can focus on client outcomes. ETFs even help mutual funds innovate. Kat Sweeney, head of ETF institutional sales in the US, notes: “Before ETFs, a $100 million inflow into a mutual fund would mean the portfolio manager had no choice but to either leave it in cash or sweep it into a money market fund. Now, that money can be put to work in an ETF that achieves similar exposure and is aligned with the fund’s objective.”
Despite all this, ETFs still represent less than 5% of the entire investable market.6 But with the ETF’s inherent liquidity advantages over individual bonds, because of intraday trading and transparency on pricing, many believe that up to 30% of insurance companies could be moving assets into ETFs.7 Millennials in the United States are using ETFs more than any other demographic group, and their usage has increased 60% in three years’ time.8 Jim is particularly bullish about the global potential of ETFs. “Right now, there are more middle-class Chinese citizens than there are American citizens total. ETFs are just scratching the surface in these markets.”
Changing the Way We Invest
Twenty-five years into their existence, ETFs have shifted the way investors think about how they invest. ETFs have become key building blocks when making asset allocation decisions, and they’ve allowed advisors to focus on investor outcomes with greater efficiency — through targeted exposure to match portfolio goals and improved transparency of underlying holdings, enabling a more streamlined due-diligence process. “It’s not that long ago that we were trading in fractions and using hand signals to communicate on the trading floor,” says Dave. “Over the past 25 years, since the launch of SPY, the markets have become increasingly automated and complex. However, this complexity has resulted in tighter spreads and greater transparency. Any way you look at it, this has been a win for investors.”
Still, Jim refuses to take credit for any of it. “When this all started, we thought that the ETF would be used mostly by trading institutions or maybe some hedge funds. Boy, were we wrong.”