The $3.4 trillion industry of exchange-traded funds is about to get a lot bigger and cheaper, too.
The Securities and Exchange Commission has unveiled aÂ new regulatory framework that allows new, low-risk ETFs to enter the marketplace without jumping over excessive regulatory hurdles. Up until now, new ETFs were required to undergo a long and costly process to comply with SEC rules.
In essence, the change lowers the barrier of entry for new applicants and levels the “playing field” for old and new entrants. As the SEC put it, it should “allow for more product innovation.”
Industry experts, meanwhile, foresee favorable outcomes for investors. The new rule will boost the number of ETFs because the new framework makes them cheaper to launch.
“Some of these cost savings will be passed on to investors,’’ said John Linton, managing member of the Colorado-based Elbert Capital Management, which constructs investment portfolios for clients using almost exclusively ETFs.
“I believe this will affect mostly new niche ETFs with lower assets under management,” Linton said. “The large ETFs that are already launched and have achieved scale shouldn't see many benefits from the regulatory change as they have already cleared the regulatory hurdles.”
The changes also will improve transparency. Under the new rule, ETFs would be required to publish an updated asset allocation on their website at the start of each business day. And, they will have to provide historical information on the disparity between traded price and the net asset value of the ETF, said Jeff Proctor, owner and creator of DollarSprout.com, a personal finance blog for millennial investors. Proctor is based in Virginia.
"This seems like a very straightforward and reasonable requirement; investors should always have an up-to-date picture of what they are investing in,'' Proctor said.
An ETF for that
As it stands, about one-third of U.S. investors hold at least one ETF, said Gabriel Pincus, president of the Chicago-based GA Pincus Funds. Most ETFs are “passively” managed to track an index. A small number of ETFs are “actively” managed and try to outperform the index they track. Active or passive, there is likely an ETF out there for everyone, he said.
You can find an ETF for virtually any asset class, including domestic and foreign equities, domestic and foreign bonds, commodities, exotic hedged and much more. An ETF generally is a basket of securities that follows an index, in some way, shape or form.
“There are ETFs that track almost every conceivable asset segment in the world, which means there is likely an ETF out there for everyone,” he said.
Prior to forming GA Pincus Funds, Pincus developed an ETF consulting practice at Deloitte & Touche. He also worked at Markit’s Index and Exchange-Traded Fund Management.
What types of ETFs should you buy?
“As with any investment,’’ Pincus said, “ETFs span the gamut from low- to high-risk.”
And there’s a warning tied to the riskier ETF, he said.
“You should not have a leveraged product in your portfolio if you are a buy and hold investor. If owned correctly, ETFs offer diversification, which is a portfolio requisite for all investors.”
Pros and cons
Proctor, owner of DollarSprout.com, said ETFs are generally preferred by any long-term investor who wants “broad exposure without worrying about in-depth individual stock research or daily stock monitoring.”
A major benefit is that ETFs “in general, have lower fees than actively managed mutual funds and multiple studies have shown that index funds consistently outperform actively managed mutual funds over the long-term,” Proctor said.
There isn’t one ETF that is better than any other, said Linton, of Elbert Capital Management.
The answer “depends on each investor’s needs and also their expectations of future performance,’’ Linton said. “If the investor believes that technology will outperform the rest of the economy in the future, the Invesco QQQ Trust ETF (QQQ, Financial) may be the best choice." The Invesco QQQ Trust ETF tracks a modified-market-cap-weighted index of 100 Nasdaq-listed stocks.
However, "If the investor is looking to avoid concentration risks and wants to have a more diversified portfolio, SPDR S&P 500 ETF (SPY, Financial) may be a better choice," Linton said. "It is important for an investor to understand the attributes of the ETF they are investing in and make sure it is a fit with their strategy.”