The day was October 19, 1987, a day now known to investors across the world by the darker moniker “Black Monday.”4 Global markets plummeted so precipitously that the drop and the resulting damage to the stock market would ultimately prove more significant than the Great Depression. Almost immediately, regulators began asking, what had gone wrong? The US Securities and Exchange Commission later said that automated orders for every stock in an index were at least part to blame for the crash, and concluded that the creation of a market maker to trade a basket of stocks "might alter the dynamics of program trading."5 It was an open invitation to the investment industry to create a new product.
Fast forward to the winter of 1993, when a group of financial executives rang the opening bell of the American Stock Exchange to launch the first Exchange Traded Fund (ETF) in the US —the SPDR® S&P 500® ETF — with the ticker symbol SPY6. After more than three years of collaboration between State Street (then known as State Street Bank) and the American Stock Exchange, the basket of securities that tracks the performance of the S&P 500® index was finally making its debut.
One face, however, was missing from the bell-ringing celebration in New York. State Street’s Jim Ross was back in his Boston office where he’s been tasked with making sure the launch goes smoothly.
The weeks leading up to the launch held many sleepless nights for Jim and the State Street team responsible for making sure all of the inner workings of the product were in good order. There were many test runs that mimicked moving 500 securities from a broker-dealer to State Street while they were delivering back shares that can then be sold by the same broker-dealer on the stock exchange. It’s never been done before – no one is even 100% sure it can be done.
“I was part of the project team that brought the original SPDR to market. It was a long process because it was new and innovative. At the time, honestly, we we’re just hoping it would work. There were no assurances of that, and we were hoping people would be interested in it,” Ross recalls.
The American Stock Exchange (acquired by the New York Stock Exchange in 2008) had initially approached the indexing pioneer and custody/clearing giant because of its proven experience in managing to very specific criteria – in this case, State Street’s portfolio management skills and money movement capabilities. But the ETF presented some unique challenges.
With an ETF, while the product trades on the exchange like stocks and bonds, the underlying fund must have the actual holdings. “If it was a $100 million fund,” Ross says, “it needed to have $100 million in assets comprised primarily of the index.” Complicating matters, since both the money and securities must move and be settled in real time; an audit has to be conducted in real time as well. “Given that we were seeded not just with cash but also with the 500 securities of the S&P 500®, we had to have an audit of 500 individual securities,” Ross explains. “Normally, this whole process takes 45 days. But for the ETF to work, it needed to be completed in about 16 hours – between the market closing at 4pm and the next morning before markets opened. Significant planning was required to ensure that the financials could be prepared and the audit could be completed. That made for some late nights.”
SPY ultimately proved successful.
“It caught on with institutional trading communities, large investors and even buy-and-hold investors,” says Ross, now chairman of State Street Global Advisors’ global SPDR business. “They saw the ETF as a way to buy into the S&P 500® in a securitized, cost-effective* way.”
* Frequent trading of ETFs could significantly increase commissions and other costs such that they may offset any savings from low fees or costs.
One significant early investor in SPY is a pension fund not from the United States but Australia. “Back then,” Ross says, “buying a mutual fund required you to fill out an application. It was a very different process. This was something you could buy on the exchange. So suddenly, you had foreign pension funds buying and holding it to get pensioners halfway around the world exposure to US equity markets.”
By 1999, the ETF has crossed the Pacific, with State Street Global Advisors launching the first ETF in Hong Kong; the first ETF in Australia in 2001; and Singapore saw its first local ETF listed in 2002.
A quarter century after the launch of SPY there are now over 6,500 ETFs globally that track specific industries, sectors, commodities and geographies, SPY remains the most traded ETF.7
One of the first tests of the ETF in choppy markets came in the wake of the September 11th, 2001 attacks when the US stock exchanges were closed for six days – which was the first exchange trading disruption of longer than four consecutive days in the previous 50 years. When markets reopened on September 17th, investors heavily sold off industries like the airlines that had been impacted. 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.8 9/11 was the first but not the last time this happened. ETFs have shown that they add an incremental but essential source of liquidity to the market through 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.
Twenty-five years on, ETFs have shifted the way investors think about how they invest. ETFs have become key building blocks to make asset allocation decisions. They have allowed investors to focus on outcomes with greater efficiency – through targeted exposure to match portfolio goals and transparency of underlying holdings in a simple transaction. Even as ETF assets are predicted to grow to US$7 trillion by 20219, Ross refuses to take credit for the global ETF revolution. “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,” he says.
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