The Last Word: ETF Trading Grown Up

[This article appears in our February 2020 issue of ETF Report.]  

Exchange-traded funds’ most important feature is perhaps their “traded” aspect. After all, that’s the game-changer driving their popularity.

Investors can move in and out of ETFs easily any time during the trading day, and aren’t constrained to putting in a single order to be filled after the market close.

That’s the force behind the ETF revolution. And one little tweak last year to the traditional mutual fund structure that was enshrined by the SEC in 2019 thanks to “the ETF Rule,” allows would-be ETF issuers to skip seek seeking additional exemptive relief to launch products.

All Grown Up
You could say that 2019 was the year ETFs grew up, when ETFs became more like their mutual fund big brothers, and also even more separated from them. That’s also the year that firms finally got approval to launch nontransparent ETFs, further removing them from that modified mutual fund structure to a new unexplored territory with its own set of rules.

ETFs have come a long way. They closed out 2019 with more than $4.4 trillion in assets under management on inflows of $326 billion, second only to 2017’s record-breaking flows of $476 million.

Launches and closures were also unremarkable: 256 new funds and 125 closures, numbers that are perfectly respectable and that reflect a maturing industry.

ETF Bogeyman Myth
But that maturity hasn’t come without a struggle. The past year saw yet another wave of stories and speculation about whether ETFs (and index funds in general) would cause the next big market crash.

ETFs’ 30th birthday in the U.S. will happen in 2023, and there haven’t been any major hiccups. There’ve certainly been some ugly blips—messy product closures, unexpected shifts in objective, the occasional “flash crash”—but nothing that’s derailed an industry built around the premise that investors should be able to smoothly invest and extract their assets from an investment vehicle at will.

When you think about it, ETFs are providing the kind of convenience and customization capabilities for investors that services like GrubHub and Uber only now offer people in their everyday lives. And while GrubHub and Uber were not even glimmers in their creators’ eyes when the SPDR S&P 500 ETF Trust (SPY) burst onto the scene in 1993, ETFs have seen this culture of efficiency and convenience coalesce around them and accommodate them rather than having to carve out their own niche.

Direct Indexing’s No Threat
There’s been a big hullabaloo around the direct indexing concept, and it’s been presented as a challenger to ETFs. While direct indexing reflects the mores of our age of convenience and customization by allowing investors to precisely fine-tune their exposures to reflect their exact portfolio needs and life situation, this is just another choice of tools to investors—not an existential threat to the $4.4 trillion U.S. ETF Industry.

Direct indexing is a cool idea, as are ETFs. But ETFs are easily investable, easily tradeable, and can fill the needs of investors at any level. Direct indexing is aspirational for most investors, and in its current nascent form, not nearly as flexible, portable or understandable as an ETF portfolio.

ETF portfolios are not as granular as a direct indexing portfolio. They’re … chunky, with each ETF representing an entire asset class, often as not.

But, in a mature and liquid market, you can trade those chunks at will to come up with a pretty good asset allocation and adjust it as needed.