ETFs have come a long way since the 1993 launch of the first ETF, the SPDR S&P 500 ETF (SPY | A-98), as a means for institutional investors to hedge and manage their cash. Since then, the industry has grown to include more than 1,577 U.S.-listed ETFs, with more than $1.756 trillion in assets under management.
Today ETF issuers and advisors are marketing the products as more cost efficient and transparent than their mutual fund counterparts, and investors are buying into the pitch. While cost does matter, investors diving into ETFs should also understand the index methodology powering the ETFs, according to Deborah Fuhr, partner and co-founder of London-based research shop ETFGI.
Fuhr, who previously served as the global head of ETF research and implementation strategy at BlackRock /Barclays Global Investors, spoke to ETF.com staff writer Hung Tran on the sidelines of the Capital Link Closed-End Funds and Global ETFs Forum about why index methodology should also matter to investors.
ETF.com: What priorities should investors have in place when they feel they’re ready to dive into ETFs?
Fuhr: When you think about using ETFs, the first thing you think about is, “What are my financial goals?”
But you should also ask yourself, “Where do I want to invest?” And if you want exposure to U.S. markets, which benchmark represents that exposure? Do you want a narrow blue chip index or something broader?
Or do you want something tilted and more fundamental, so instead of using market cap, the index will be looking at underlying company sales, price-to-earnings ratio and dividends? You will find different benchmarks will have different biases. So the S&P 500, which most people understand, is a market-cap index.
[But] there are equal-weighted S&P indexes, and so when you equal-weight the index, you’re raising the index’s allocation to small-caps. So small-caps will do better than large-caps, but depending on the market environment, you’ll find that large-caps can do better.
If you think about a fundamental benchmark, which is using a number of factors to reconstitute a market-cap index, you’ll often find there’s a value tilt. So, clearly, sometimes value stocks do well, while other times growth stocks do well.