Explore the roots of exchange-traded funds (ETFs), the factors fueling their extensive acceptance, and their evolution alongside market changes. Below, we delve into these elements to understand how ETFs cemented their place in the financial sphere.

Upon their introduction in 1993, exchange-traded funds (ETFs) made a quiet entry, barely noticeable among everyday investors. Despite major investors recognizing their potential over the following decade, ETF trading remained minimal, barely hitting the 1% mark in fund trading by 2000. Retail investors mostly opted for routine contributions to their 401(k) mutual funds during that time. Today, however, ETFs stand as a popular choice for both institutional and individual investors, recently accounting for 26% to 30% of daily trading volume in the U.S.

Promoted as a more cost-effective and superior alternative to mutual funds, ETFs are known for low costs, straightforward trading, and passive investment appeal. The primary benefits are their lower fees and trading flexibility. Unlike mutual funds, which are valued once daily post-market close, ETFs can be bought or sold throughout market hours, similar to individual stocks. This flexibility allows quick response to market events, the application of advanced trading strategies, and waiting out short-term market fluctuations to benefit from passive index ETF holdings.

ETFs initially drew from portfolios like the S&P 500 and other indices. A significant shift in the early to mid-2000s enabled funds to encompass bonds (2002), commodities (2004), currencies (2005), inverse products (2006), real estate investments and trusts (2000), and volatility (2009), among other assets. Nonetheless, none caused as much stir as the arrival of cryptocurrency futures (2021) and spot crypto ETFs (2024).

The brokerage sector has highlighted the advantages of ETFs, with many offering commission-free trades on select ETFs to gain and keep clients. As debates over crypto funds have demonstrated, ETFs represent a path for mainstream investment capital to target financial sectors previously inaccessible via U.S. stock exchanges, including commodities, volatility, and cryptocurrencies.

By the end of 1993, mutual funds reached a staggering $1.5 trillion in assets, solidifying the year as pivotal in investment fund history. Once the public’s appetite for indexed funds was apparent, the race began to make these investment styles more accessible. Despite their expense, complexity, and illiquidity, mutual funds remained popular, though often requiring minimum investment amounts.

The Vanguard 500 Index Fund, a prominent example of mutual fund success, underlines the foundation of mutual funds and influential figures like Vanguard’s founder as essential when ETFs emerged as a cornerstone of contemporary investing.

Around the time index funds evolved, advancements in trading technology and financial engineering occurred. In the 1980s, stock index futures and options were introduced, permitting investors to hedge or speculate on anticipated future stock index values.

In 1990, the Toronto Stock Exchange began offering shares in the Toronto 35 Index Participation Units (TIPs 35), an instrument based on warehouse receipts that tracked the TSE-35 Index, a Canadian ETF precursor. State Street Global Investors launched the first American ETF three years later. While initially launching in 1993, it wasn’t until 15 more years later that the first actively managed ETF entered the market.

From a single fund in 1993, the market expanded to 102 by 2002 and almost 1,000 by 2009’s close. Entering the ETF arena in 1996, Barclays joined, while Vanguard started offering ETFs in 2001. As of 2024, over 12,000 ETFs circulated globally, with approximately 600 different fund management companies providing them.

Though mutual funds initially received public attention, ETFs launched in 1993 without similar fanfare. Despite the dot-com era’s significant growth, trading levels stayed low throughout the 1990s. By 2000, ETF assets barely reached 1% of mutual fund assets.

This began to change as many in the investment community saw ETFs—traded on U.S. exchanges like any stock—as offering access to off-exchange assets through regulated brokerage accounts. Previously, specialized brokers were necessary for commodities market trades. Now you could invest in gold indirectly by buying shares representing fractional ownership in an ETF holding it in its portfolio.

During the 2000s, ETFs expanded into new asset classes and strategies, transitioning from a niche to an essential tool for retail and institutional investors. The decade began with ETFs focused on broad market indices. The iShares MSCI EAFE ETF, launched in 2001, provided exposure to international stocks (excluding the U.S. and South Korea), simplifying global diversification with a single share purchase.

Bond ETFs gained prominence around that era—currently the second-most traded ETF type after equities—boosted by the iShares Barclays Aggregate Bond ETF’s introduction in 2002.

With the SPDR Gold Shares debut in 2004, investors could hedge or speculate on foreign exchange (forex) rate changes.

ETFs evolved, offering strategies beyond passive investing. Investors accessed sophisticated tools to enhance returns or leverage market downturns. For instance, ProShares launched its first leveraged and inverse ETFs in 2006, providing two times or negative-two times the daily market index returns. These tools were appealing amid the volatility before and after the 2008 financial crisis.

The rapid ETF industry growth attracted regulatory examination. In 2008, the U.S. Securities and Exchange Commission (SEC) began a thorough review of ETFs, especially those employing derivatives and complex strategies. Despite SEC concerns, ETF flexibility and variety continued drawing a diverse investor base. By the decade’s end, ETFs surged in number, and assets under management (AUM) for U.S. ETFs neared the $1 trillion mark.

During the last decade, themes like robotics, AI, and clean energy captured investor interest through thematic ETFs. These funds let investors target speculative or cutting-edge sectors without needing extensive industry-specific knowledge.

As the 2007-2008 financial crisis subsided, fund managers continued introducing more diverse and niche products. Emerging trends included thematic ETFs focused on particular investment themes, cutting across industries like robotics, AI, and clean energy. These funds enabled investors to focus on speculative or pioneering sectors without requiring deep industry expertise.

Fixed-income ETFs also advanced, with offerings targeting specific bond maturity profiles, credit risks, and yields. Multi-asset ETFs, providing a mix of stocks, bonds, and other assets in one ETF, gained popularity for creating balanced, diversified portfolios tailored to particular risk tolerances and investment objectives.

2023 – 2024

Following a 2023 federal appeals court decision, the SEC allowed 11 spot bitcoin ETFs to initiate trading in January 2024. These ETFs grant investors direct cryptocurrency exposure, contrasting with futures-based ETFs that only track price shifts through contracts. On May 23, 2024, the SEC sanctioned applications from the NYSE, Nasdaq, and CBOE to list ETFs linked to ether prices.

2019 – 2022

In 2019, the SEC streamlined the process for launching new ETF strategies, including cryptocurrency-focused ones. Bitcoin futures ETFs received approval in 2021, followed by ether futures ETFs two years later. These allowed investors to gain exposure to digital currencies without owning them directly, with the added security of regulated futures contracts instead of actual tokens.

The regulator consistently rejected proposals for ETFs directly holding cryptocurrencies. The SEC hesitated to approve spot bitcoin ETFs due to concerns over market manipulation, liquidity, and fund security. Following major cryptocurrency platform bankruptcies, including FTX, BlockFi, and Voyager Digital, the SEC increased its oversight. In response, the SEC expanded its crypto and digital-asset staff, while Chair Gary Gensler expressed skepticism about the crypto market’s vulnerability to abuses and fraud.

The ETF landscape features prominent funds like the S&P 500 SPDR, the largest foreign equity ETF, launched in August 2001, holding about $54.9 billion in assets as of June 7, 2024.

Another leading example, the Invesco QQQ, began trading in December 2003 and boasted over $18 billion in assets under management as of June 2024.

Understanding ETFs: How They Function

ETFs are funds that securitize holdings for investor purchase and trading, offering flexibility unmatched by mutual funds, which can only be traded post-market close. This flexibility allows investors to capitalize on price shifts throughout the trading day instead of being confined to an end-of-day price.

ETFs or Mutual Funds: A Comparative Insight

Your purpose determines the better option. ETFs generally present lower average costs and enhanced tax efficiency compared to mutual funds for those inclined toward day trading. With typically passive management strategies, they incur fewer taxable events and lower fees. Meanwhile, mutual funds appeal to those averse to active trading and resulting fees, making them suitable for hands-off investors.

Are ETFs a Savvy Investment?

ETFs hold potential for investors keen on trading. With an abundance available, they contribute significantly to the market’s trading volume and liquidity.

The first ETF debuted in Canada in 1990, paving the way for the U.S.’s first ETF, the SPDR S&P 500 ETF Trust, in 1993. Created to combine diversification akin to mutual funds with stock trading flexibility, ETFs required time to rapidly grow in popularity.

Over three decades, ETFs have expanded across various asset classes, including bonds, commodities, international markets, and sophisticated instruments like leveraged and inverse ETFs. The 2000s and 2010s witnessed further diversification with thematic and ESG-focused ETFs, mirroring broader economic and societal trends. By the 2020s, the debut of cryptocurrency futures and spot crypto ETFs, although contentious, demonstrated the ETF market’s adaptability to evolving investor demands, asserting a notable presence in the contemporary investment realm.

Opinions, comments, and analyses on this platform serve informational purposes only. Please refer to our policy for additional details.