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11th June 2019 | Mateusz Groszek | Portfolio Fundamental Analyst

Why ETFs are so popular?

Twenty years ago, no one would like to ask about ETFs popularity. Time passes and some of the investors have realized what investing will look like in the future. And what now? Everyone knows about the Exchange-Traded Fund or at least has heard something about them.

Before we will go through the reason why the ETFs are so popular, we have to be familiar with the definition of the ETFs. What are they? 

An ETF is a marketable security that tracks an index, commodity, bonds or particular strategies. The main goal of an ETFs is to track the index very closely. The less deviation from the benchmark the better. There is no goal to beat the market, but to track it very closely. Almost all ETFs own the underlying assets such as shares from the S&P 500 index, then divides ownership of those assets into shares. After that, investors from all over the world can buy this ETF and receive a small share in the companies from the S&P 500 index. 

Let's go through the history of an ETFs, after that we will be able to answer why those instruments become so popular. 

History of an ETFs

The first ETF was launched in 1993 in the United States. It was used primarily by institutional investors to execute sophisticated and very advanced trading strategies. After 9 years, the first bond ETF was introduced. The main goal of those ETF was to closely track the bonds rate of return. 

In 2007, the ETFs market was at its peak with a record 269 ETFs being introduced. In 2010, the asset under management in an entire U.S. ETFs market reached its first USD 1 billion. There were more than 1 000 ETFs in the market. 

Today the Asset Under management reaches to almost 5 billion. As you see, this market is increasing each year, what is the main reason for that?

Popularity of the Exchange Traded Fund

Low cost

The main reason the ETFs are so popular is their low cost compared with normal mutual funds. Costs are associated with normal operating expenses related to, but not limited to, portfolio management fees, custody costs, administrative expenses, distributions, and marketing expenses. In the long term, those costs could lower our long-term rate of return. 

In opposite to mutual funds, ETFs work in an effectively way to lower those costs, which means that investors are able to earn a higher rate of return. Let's consider the S&P 500 index, we are able to follow this particular index for less than 0.30% of invested capital. Furthermore, usually, the ETFs distribute the dividend yield which in most cases covers the maintenance costs of the instruments. 

Liquidity 

The liquidity is another factor that makes the Exchange-Traded fund so popular. The investors are able to buy or sell those funds intraday, there is no redemption time like in mutual funds. 

Zero entry fee

The next reason why ETF have become so popular is zero entry fee and no investment minimum. Furthermore, there is no exiting fee.

Portfolio diversification and risk management

Exchange-Traded fund are open to new investors and are a simpler way of the portfolio diversification. Investors are able to gain portfolio exposure to specific sectors, styles, industries or even countries. I don’t only mean equity asset classes exposures, but also the debt instruments, commodities, and real estate. 

Tax benefits

ETFs could provide investor tax benefits. Capital gain tax incurs only upon the sale of the ETF, where, for example, mutual funds pass on capital gain taxes to the investors during the life of the investment. Furthermore, Ireland ETFs could accumulate and reinvestment the dividends, which will provide additional tax benefits.

Those are the main reason behind the growing popularity of ETFs. The investor should be familiar with them, but also should know the risk associated with those instruments. There are a few structures of Exchange-Traded fund that makes them riskier. We will continue this topic in another article. 

Golden Sand Bank ("Bank") exercised due diligence to ensure that the information contained in this publication was not incorrect or untrue as at the date of publication.

All Investment products are at risk, as their value can go down as well as up. The tax treatment of your investment will depend on your individual circumstances and may change in the future. If you are unsure about whether investing is right for you, please seek financial advice. This publication is not an investment recommendation or investment advice in connection with any services provided by the Bank to the Client.

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