What is an ETF?

Introduction

An exchange traded fund is a type of investment fund that was invented in 1993 as an alternative to a mutual fund, historically the most popular vehicle that Americans used to invest in stocks and bonds. Structurally, an exchange traded fund has certain advantages to it versus a mutual fund, including:

The structural benefits of an ETF are explained in detail in our article the benefits of an ETF.

But aside from the structural advantages, ETFs have exploded in popularity because they have become synonymous with "index investing", the idea that rather than trying to pick a mutual fund run by a fund manager, an investor should just invest in an ETF that systematically follows a stock market index like the S&P 500 or the Dow Jones Industrial Average. Many investors have concluded that since it is very difficult for a mutual fund manager to "outperform" the market, it is just as easy, and cheaper, to buy an ETF that follows an index.

The debate between investors who believe in active management of a portfolio and those who believe in passive index investing continues to rage. Read more about the debate in our article active versus passive investing.

Our database currently contains 2,340 active exchange traded funds. Our database generally includes 99% of all ETFs traded on U.S. stock exchanges, as we try to keep our database updated with all actively traded ETFs. But there may be a few ETFs that have been recently launched that are not yet setup in our database.

Here is a breakout of the ETFs in our database by category:

CategoryCountMarket cap%
1$7,737,0000.0%
Alternatives159$15,095,695,6990.3%
Asset Allocation59$13,353,811,6590.3%
Commodities124$149,995,320,5973.2%
Global Equity670$838,137,090,34317.8%
Global Fixed Income28$42,124,875,0300.9%
Special Security Types56$43,398,515,6160.9%
US Equity866$2,664,129,472,07556.7%
US Fixed Income 377$936,113,824,70619.9%
Total2,340$4,702,356,342,725100%

As shown in this table, most ETFs today track an index:

Investment StyleETF CountMarket cap%
1$00.0%
Actively managed343$129,782,739,0022.8%
Buys and sells commodity futures on a set pattern11$5,622,235,8110.1%
Follows a set investment pattern3$156,690,1610.0%
Other78$4,327,786,2300.1%
Passively tracks an index1,879$4,429,447,834,82494.2%
Physically owns a precious metal13$131,639,235,8162.8%
Tracks price of currency exchange rates12$1,379,820,8810.0%
Total2,340$4,702,356,342,725100%

The growth of the ETF industry has been steady, and at times explosive. Let's look at the launch date of the ETFs currently in our database:

Year of InceptionCount
19931
19951
199617
199810
19991
200045
200122
20026
200311
200432
200542
2006115
2007161
200881
200984
2010105
2011106
201294
2013102
2014123
2015150
2016149
2017197
2018229
2019258
2020198
Total2,340

Note that there were actually even more ETFs launched then this table shows, as we are only displaying the launch dates of ETFs still active in our database. There were hundreds of more ETFs that were launched during these years that have since been closed down by their sponsor.

Gold and Silver ETFs

The growth in the ETF industry has been partly fueled by the industry inventing other ways to use ETFs as a vehicle, besides just purchasing stocks and bonds. In 2004, State Street Global Advisors launched GLD, the SPDR Gold Shares ETF, an ETF that allow investors to invest in gold in an innovative way. GLD tracks the price of gold, because GLD actually uses the money invested in the fund to buy gold and store it in vaults around the world. Soon thereafter, other gold and silver ETFs were launched, fueling the growth in the ETF industry.

The success of these ETFs has dramatically changed the way people buy gold, silver and other precious metals. There are now 13 ETFs in our database that buy precious metals, including gold, silver, platinum and palladium, and store it in vaults around the world:

Precious MetalCountMarket cap%Fees
Broad market1$719,023,5000.5%0.60%
Gold7$115,190,875,31687.5%0.34%
Palladium1$384,858,0000.3%0.60%
Platinum2$1,052,171,0000.8%0.60%
Silver2$14,292,308,00010.9%0.49%
Total13$131,639,235,816100%0.36%

Exchange Traded Notes

Another invention that spurred the growth in the ETF industry was the invention of exchange traded notes or "ETNs" in 2006. An ETN acts like an exchange traded fund but is different in structure. An ETN is issued by a major international bank like UBS or Credit Suisse, and it represents an unsecured liability of the bank. When an investor gives the bank money by buying an ETN, the bank promises to pay the investor a return based on the returns generated by an index. The bank can use the money however it sees fit, as the bank is not required to segregate the assets from an ETN from the bank's other assets. So obviously an investor is trusting the bank to have the financial resources to honor the ETN. Read our separate article for more details on what is an ETN?

Many people use the term "exchange traded product", or ETP, to refer to both exchange traded funds and exchange traded notes. Honestly, there are times when many people, including us, generically use the term "ETF" to refer to both true ETFs and ETNs. Here are the number of active ETPs in our database as of today, by type:

ETP TypeCountMarket cap%
ETF2,233$4,696,168,564,44099.9%
ETN107$6,187,778,2850.1%
Total2,340$4,702,356,342,725100%

Leveraged and inverse ETFs

In 2006, ProShares launched a series of "leveraged" and "inverse" ETFs, starting the growth of leveraged and inverse ETFs, which have now become a huge part of the ETF industry. A leveraged ETF is an ETF that attempts to track 2x, 3x or even 4x of the results of the index it is tracking. Similarly, an inverse ETF is an ETF that attempts to track 2x or even 3x of the inverse or opposite results of an index.

How do they do it? Leveraged and inverse ETFs typically buy and sell swaps and other derivatives that are complex and difficult to understand. A "swap" is a complex agreement between the ETF and one of the large international investment banks like Goldman Sachs or UBS, which allows the ETF to achieve the leverage they want through a derivative rather than actually borrowing money.

The most controversial aspects of leveraged and inverse ETFs is that they can have a tough time accurately tracking their index over long periods of time because they reset their leverage on a daily basis. The effects of resetting leverage on a daily basis are explained in our article what is a leveraged ETF?

Although the use of leverage in general, and leveraged ETFs in particular, are controversial, they have become very popular:

Leverage factorNumber of ETFsMarket cap
-3.0025$4,761,276,870
-2.0042$4,241,829,640
-1.0031$5,918,459,511
1.231$47,451,250
1.256$121,446,264
2.0062$15,468,480,864
3.0044$19,924,261,487
4.0010$15,152,434
Total221$50,498,358,320

Actively Managed ETFs

In 2008, the first "actively managed" ETF was launched. As mentioned above, ETFs are really synonymous with index investing. But an actively managed ETF does not follow an index. Rather, a fund manager makes investments for the ETF, in the same manner as a traditional mutual fund. The fund declares up front what its investing strategy will be (within broad strokes), but the fund manager typically has broad discretion to make whatever investments he or she feels is appropriate. Read our separate article on what is an actively managed ETF?

Our database contains 343 actively managed ETFs:

CategoryCountMarket cap
Alternatives29$2,693,129,136
Asset Allocation32$7,449,704,749
Commodities16$3,690,608,859
Global Equity43$15,899,933,543
Global Fixed Income 7$782,918,208
Special Security Types8$815,787,713
US Equity100$8,150,846,000
US Fixed Income 108$90,299,810,794
Total343$129,782,739,002

Most actively managed ETFs are fairly new:

Year of InceptionCount
20072
20083
20093
20104
20114
20129
201313
201433
201513
201632
201750
201859
201958
202060
Total343

Even though many ETF investors are died in the wool believers in index investing, actively managed ETFs will probably continue to grow in number and popularity in the future, because of the structural advantages of an ETF compared to a traditional mutual fund. Despite the growth of ETFs, mutual funds continue to be the most popular pooled investment vehicle in the United States. So there are still thousands of actively managed mutual funds that theoretically could be launched as an ETF instead.

Smart beta ETFs

Over the past few years, a major trend in the ETF industry has been the launch of so-called "smart beta" ETFs. Smart beta ETFs follow an index, but they follow indexes that have been designed to outpeform the market. Some ETF providers use the term "strategic beta" to refer to the same thing.

The terminology takes a little explaining. Historically, when analyzing the performance of a portfolio, the term "alpha" was used to refer to the excess return generated by the portfolio manager, above and beyond the return of the market, by actively selecting stocks, while "beta" was used to reference the return of the market itself. So the term "smart beta" is a play on those words.

Historically, portfolio managers of actively managed mutual funds have always attempted to achieve alpha - i.e. they want to outperform the market. At the same time, an index fund, like an ETF that tracks an index like the S&P 500 Index, was really just seeking to match the returns of the market, so it was seeking "beta". The term "smart beta ETF" was coined because an ETF that tracks a smart beta index is somewhere in the middle: it isn't really a portfolio manager actively seeking "alpha", and it isn't really just seeking "beta".

It is a controversial question as to whether you can design an index that really does achieve "alpha" over long periods of time, so smart beta ETFs have their proponents and their critics. The original idea behind index investing was that since it is so difficult to outperform the market, an investor should just "own the market". So smart beta ETFs are somewhat controversial because they are attempting to appeal to investors who want to "outperform the market". Read our separate article on what is smart beta?

Smart beta proponents argue that academic research and historical data mining has determined that you can identify certain "factors" that contribute to one stock outperforming another stock over long periods of time. For example, most research has concluded that over long periods of time, the stocks of smaller companies generally outperform the stocks of larger companies. So "size" is one factor that many "smart beta" ETFs use in an attempt to achieve alpha. Many ETF providers use the term "factor investing" or "factor ETFs" interchangeably with the term "smart beta ETFs".

There isn't necessarily a standard definition of what constitutes a smart beta ETF. We define a smart beta ETF to be any ETF that seeks to track an index that is either 1) selecting the securities to be including in the index using an investment factor like value or quality, or 2) weights the securities in the index using a method other than the market capitalization of each security.

Despite the controversy, smart beta or factor ETFs continue to be launched at a high rate. Here are the number of smart beta ETFs in our database:

CategoryCount
Alternatives 31
Asset Allocation20
Commodities26
Global Equity269
Global Fixed Income1
Special Security Types18
US Equity 550
US Fixed Income41
Total956

Future developments

The ETF industry continues to grow and innovate. At times, the number of ETFs available is overwhelming, but the ETF industry seems like a Juggernaut that cannot be stopped. Read our separate educational article on future industry developments.


All data is a live query from our database. The wording was last updated: 11/16/2018.

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