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Happy 20th Birthday, ETFs!

State Street's SPY sparked a revolution that's reshaping investing


Former Federal Reserve Chairman Paul Volcker likes to say the only useful innovation to come out the modern financial services industry is the invention of the automated teller machine.

Maybe Tuesday’s 20th birthday of the SPDR S&P 500 ETF (NYSE:SPY) will remind him of another great innovation: Exchange-traded funds.

Yup, it’s hard to believe, but State Street Global Advisors — the asset management arm of State Street (NYSE:STT) — launched the world’s first ETF two decades ago.

True, it took a good 15 years for these products to gain decent traction, but man, has it been worth the effort.

Make no mistake: ETFs have been a blessing for investors. Since almost all of them are passively managed index products, they come with low fees. However, unlike indexed mutual funds, which price only once a day, ETFs trade all day long on an exchange — like stocks. That means they’re liquid, or easy to buy and sell.

And, of course, they’re also transparent, especially compared to actively managed funds, which report holdings quarterly. Since ETFs simply track an index, you know your positions and weightings at all times.

Low cost, liquidity and transparency make ETFs a boon to investors. And it all started with the SPY.

Launching on Jan. 29, 1993, with just $6.5 million in assets (roughly $10.3 million in today’s dollars), the SPY has grown to $123 billion in assets under management, making it the world’s biggest ETF. With an average daily trading volume of 144 million shares, it’s the world’s most-traded ETF, too.

That’s why when traders say they’re buying or selling the market, they usually mean they’re long or short the SPY (or some derivative of it).

The SPY really did change the landscape for investors, both professional and regular Joes. As Greg Ehret, chief operating officer at State Street Global Advsiors, puts it in a media release:

“The SPDR S&P 500 ETF is a core portfolio holding for a growing number of investors because it remains true to its original goal: to provide investors large and small with liquid, low cost, transparent access to the S&P 500 Index. The way in which various investors construct portfolios is very different today than it was twenty years ago due in part to the SPDR S&P 500 ETF and the industry that was created by its launch.”

Yes, State Street is tooting its own horn, here, but Ehret’s right. And the ever-growing popularity of ETFs can’t be denied.

Global ETF assets are rising at 27% a year, according to State Street. True, they’re still dwarfed by the assets managed by mutual funds, but ETFs are where all the growth is.

Partly that’s because mom-and-pop investors have woken up to the benefits of index investing. After getting creamed in the last market crash, it seems folks have finally accepted the fact that the vast majority of mutual fund managers fail to beat their benchmarks every year.

When you index, you always underperform by a little bit because of fees — but you never lag by a lot. Increasingly, retail investors have come to the conclusion that if you can’t beat ’em, join ’em.

Indeed, even as money has been pouring out of equity mutual funds for almost two years, ETFs have been expanding.

Equity mutual funds have seen monthly net outflows for 22 straight months, stretching back to March 2011, according to fund-tracker Lipper. True, most of that cash has been going into bond funds, but a good chunk has also flowed into equity ETFs.

The ETF inflows don’t make up for the amounts coming out of mutual funds, but they do show that investors are embracing the advantages of exchange-traded products over lumbering mutual funds.

Last year, $108 billion exited equity mutual funds, while $111 billion entered equity ETFs, according to Lipper. In 2011, investors pulled nearly $94 billion out of equity mutual funds and put more than $43 billion into equity ETFs.

When State Street launched the SPY 20 years ago, it really did start a revolution — one that’s still very much in the early stages. After all, with more than $10 trillion in assets under management, mutual funds are still nearly 10 times times bigger than ETFs.

It’s not often Wall Street comes up with a new product that gives investors greater choice and utility while actually lowering costs. So, Happy Birthday, SPY. ATMs and ETFs are two financial innovations we couldn’t imagine doing without.

As of this writing, Dan Burrows did not hold positions in any of the aforementioned securities.

Article printed from InvestorPlace Media,

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