New ETFs Arrive With Fewer Stocks, More Risk
- Newer ETFs are holding fewer assets as broad passive funds saturate the market.
- Active funds with higher fees are the fastest-growing category.
- Investors risk diminishing returns, a Morningstar report notes.
Once seen as mutual funds that trade like stocks, exchange-traded funds have grown increasingly specialized. More than ever, investors must kick the tires and look under the hood before buying.
More choice may sound inviting as investors get to choose from a range of themes, weightings, time frames and sectors not imagined in years past. Variety looks good through certain lenses.
That variety is a result of a few things: creativity on the part of issuers molding a flexible format to find new opportunities; the market getting saturated with massive, passive index-tracking funds like the Vanguard S&P 500 Trust (VOO); and issuers looking for ways to generate fees via high-expense-ratio, active products.
However, with ETF numbers marching up to the 4,434 that trade currently, investors now have to watch carefully at what they are buying because these new products are not the "mutual funds that trade like stocks" of old.
That’s the message in a Morningstar study published June 25, The Hidden Risks in New ETFs. The study, from Senior Manager Research Analyst Daniel Sotiroff, carries the subtitle “More than ever, investors need to know what they own.”
The U.S. ETF industry began in 1993 with the launch of what was the early industry prototype, the SPDR S&P 500 ETF Trust (SPY). That ETF acted like dozens of mutual funds by giving investors a bit of every stock in a broad index, and it charged a low fee.
The industry grew slowly so that, by 2000, only 80 funds were trading, according to a 2023 article by CNBC’s ETF expert Bob Pisani.
VOO, SPY & IVV: 3 Big Funds, 17% of the Market
Today, the market is crowded. The three biggest ETFs—VOO, SPY and the iShares Core S&P 500 ETF (IVV)—all track the S&P 500 and control 17% of the $11.1 trillion market. Investors have low-cost options to invest in broad gold, oil, tech and other indexes.
New funds are entering the market by specializing. Actively managed funds, which charge higher fees than their passive counterparts, now make up more than half of all exchange-traded funds, the total more than doubling over the past five years, Bloomberg recently reported.
As a result, the risk of not meeting benchmarks is rising, Sotiroff wrote.
“More and more ETFs are amplifying risks and falling short of expectations,” his report stated. “Buyer beware. Any stock ETF with fewer than 100 holdings is a red flag.”
