By Alexey Afanassievskiy, Executive Director and Head of Portfolio Management, Mind Money
Exchange-traded funds (ETFs) are experiencing an unprecedented surge in popularity, leaving traditional mutual funds in the dust. Recent data shows that ETFs’ market share has more than quadrupled. Active strategies have gained over $370 billion in flows, which is a stark contrast to the almost $1.8 billion lost by active mutual funds.
The growing interest in ETFs raises the question: are ETFs hype or a real opportunity for investors? Let’s delve deeper into the topic.
Why are ETFs such a hot topic today?
In fact, ETFs appeared more than 30 years ago. In 1976, John Bogle, the founder of The Vanguard Group, launched the first index fund. His concept was to precisely mirror the composition of a stock market index and offer it as a distinct investment with significantly lower fees. ETFs have undergone major changes since those times. While they are not new to the market, it is possible to understand why they have become so widespread today.
Today’s market is highly efficient, so it is often better to replicate successful strategies rather than seek out inefficiencies as before. Of course, ETFs are not a pill for all diseases, and there may be pitfalls in investing in them, too; nevertheless, they may present a good investment opportunity for both qualified and novice investors.
Diving into the benefits of ETFs
ETFs possess a number of advantages, which make them extremely attractive. First of all, I would like to mention that, in comparison with classic hedge funds, ETFs operate based on a well-defined algorithm, providing investors with clear expectations of their future revenues.
Additionally, ETFs must strictly follow their prospectus and outlined strategy. While this adherence does not guarantee higher or lower returns, it does provide investors with confidence in their market behavior.
Such a feeling of assurance due to known returns and algorithms may explain the surge of ETFs. Research shows that against the current uncertainty, investors more often turn to funds, particularly fixed-income ones.
ETFs boast high trading volumes and negligible maintenance costs—even complex ETFs with sophisticated strategies often come with minimal management fees. This may be very appealing, as the main holding cost for an ETF investor is the annual fee. Statistics show that investors tend to buy ETFs with lower fees, for example, 0.1%.
Moreover, an ETF is classified as a security. For example, if you invest in futures and face problems with a broker, exchange, or other intermediaries, the risk of losing your investment is high. In contrast, ETFs are securities held in your account, and, barring broker fraud, they offer greater protection compared to traditional derivatives.
Expanding investments horizons
Today, we witness the approval of Bitcoin ETFs and other funds linked to different cryptocurrencies. But the range of ETFs also expands in other fields. Along with it, investors gain access to increasingly diverse and innovative options, enabling them to meet any investment goals.
Nevertheless, it’s important to consider the downsides as well. While ETFs often appear to be an excellent option, there is still room for improvement. For instance, interest in Bitcoin and other digital asset ETFs once hit all-time records, but now we see significant outflows of funds. This raises the question: Is it right to use ETFs for investing in such risky assets?
If investors still decide to examine ETFs more closely, it’s crucial to balance risk and return. However, these two factors are often at opposite ends of the spectrum and cannot be maximized simultaneously. In the long run, the optimal strategy is to diversify and buy different ETFs—avoid putting all your eggs in one basket.
