The author of this article tours the history of ETFs to the present day, examining the reasons for their continued popularity – and a few potential problems.

Exchange-traded funds are now a familiar part of the wealth management toolkit, and the ETF market has boomed in past decades. What explains their ascent, what uses do they have, where is innovation taking place and what are the risks and downsides to ETFs? To give a balanced assessment is Alexey Afanassievskiy, executive director and head of portfolio management at the European broker Mind Money. 

The editors are pleased to share these views and we invite readers to jump into the conversation. The usual disclaimers apply to views of outside contributors. Email tom.burroughes@wealthbriefing.com

Exchange-traded funds have gained popularity among active investors. In the last five years, the market share of active ETFs has more than quadrupled. Active strategies have picked up more than $370 billion in inflows. Moreover, investors feel positive about the growth of the global ETF market. By 2028, the global volume of the ETFs' sector could exceed $19.2 trillion in AuM. 

Is it a typical short-run hype or a wise investment strategy? Let's figure it out. 

ETFs are almost 30 years old. How did they appear? 

ETFs are actually far from a new thing; they appeared more than 30 years ago. In 1976, John Bogle, founder of The Vanguard Group, created the first index fund. His idea was to accurately replicate the structure of an exchange index and sell it as a separate asset, charging much lower commissions. 

In 1990, the first ETF appeared, replicating a portfolio of shares from the Canadian index, and in 1993, the very "spider" ETF (SPDR), which repeated the S&P index, was created. Thus, the ETF is not an emerging phenomenon; it has been around in the financial world for more than 30 years. 

At first, ETFs were limited only to index duplicating. There was a convenient way to collect a basket of stocks that correlated with the index. Later, other tradable funds appeared, which wrapped other assets, such as physical gold and even full-fledged trading strategies. The first feature of an ETF was the ability not to collect a portfolio of shares yourself or not to buy physical gold but simply to buy a security paper.

Benefits of ETFs: confidence and safety 
Firstly, the ETF has a clearly defined algorithm. Unlike management companies, investors know exactly what results to expect. At the same time, the volumes in ETFs are usually very large, and the maintenance costs are insignificant. Some of the ETFs have low fees, even for complex ETFs that implement non-trivial strategies, coming out directly from the returns.

Additionally, an ETF is technically considered a security. For instance, if you invest in futures and encounter issues with a broker, exchange, or other intermediaries, there's a high probability of losing your investment. In the case of an ETF, these are securities that are in your account, and, in the absence of fraud on the part of the broker, they are much better protected than classic derivatives.

ETFs now encompass a wide range of strategies. Buyers can choose funds for their portfolios based on various market views. However, unlike hedge funds, which are often flexible in managing client assets, ETFs are bound to adhere strictly to their prospectus and stated approach. This doesn't guarantee higher or lower returns, but it does ensure confidence in market actions.

Beyond low commissions and security, the synergy between index ETFs and futures advances their utility in active strategies. For instance, selling short positions using sold index futures can be profitable since their prices are higher, excluding interest rates and dividends. Statistics show that demand for active ETFs is rising – nearly 80 per cent per cent of ETF investors have purchased at least one active ETF in the past year. 

ETFs may not be as positive as they seem at first sight
Despite a number of advantages, ETFs may also entail some drawbacks. The biggest disadvantage is market risk, meaning that ETFs are subject to the same market risks as the underlying assets they track. For example, if investors buy an S&P 500 ETF and the S&P 500 goes down 50 per cent, nothing will help them – ETFs are not a safe haven.

ETFs are sensitive to market movements, economic events, and changes in investor sentiment. This volatility can be particularly pronounced in ETFs that track sectors, commodities, or emerging markets, where price swings can be more dramatic. Additionally, during periods of extreme market stress, ETFs can experience rapid price declines, and their liquidity can dry up, making it challenging for investors to exit their positions at favourable prices.

Furthermore, research shows that the benefits of buying ETFs can be over evaluated – the approach to investment is far more important than what to invest in. A study by UTS found that ETF portfolios underperformed non-ETF portfolios by 2.3 per cent annually; however, the result was explained not by the ETFs but by the buy-and-hold strategy. 

Recent changes transformed the world of ETFs. How? 
The recent introduction of the bitcoin ETF highlights a significant trend in the evolution of exchange-traded funds. Unlike traditional ETFs, bitcoin ETFs are a new addition, generating considerable hype and capturing widespread attention – nearly a quarter of investors (23 per cent) are most optimistic about digital currency ETFs. Such innovations in ETFs are making them more sophisticated, resembling structural products with advanced security algorithms. 

While these specialised ETFs appeal to a smaller, niche audience, their complexity and targeted nature mean that they require careful explanation and understanding. Both private investors and companies should evaluate their needs and strategies, ensuring that interest in ETFs continues to grow.

About the author

Alexey Afanassievskiy is executive director and head of portfolio management at the European broker Mind Money. He is a financial services professional and a C-level executive, with more than 30 years’ experience in the stock market.