The Curious Case of Exchange Traded Funds or ETFs

First thing first, it is important to mention that ETF is an instrument that allows you to invest in a fund that makes investments in stocks, bonds, or other assets and, in return, to receive an interest in that investment pool. ETF shares are traded on a national stock exchange.

In the beginning, the main idea behind ETFs was to track the performance of specific U.S. equity indexes.

The most recent ETFs, however, also seek to track indexes of fixed-income instruments and foreign securities. In addition, newer ETFs include ETFs that are actively managed - that is, they do not merely seek to passively track an index; instead, they seek to achieve a specified investment objective using an active investment strategy.

Over the last few years, the exchange-traded fund market has been growing if not exponentially than at least rapidly. According to a study provided by Brown Brothers Harriman & Co. (the oldest and one of the largest private banks in the United States), the market now represents a $6.3 trillion industry and is growing at an annual rate of 32%. Quite astonishing, isn’t it?

In the time of Covid-19, this trend has become even more pronounced. Investors prefer putting money into ETFs rather than mutual funds. Even the Fed began directly buying ETFs as part of a stimulus package. In this context, Wall Street has been betting heavily on ETFs like BlackRock’s iShares iBoxx $ Investment Grade Corporate Bond ETF (that seeks to track the investment results of an index composed of U.S. dollar-denominated, investment-grade corporate bonds) and iShares iBoxx High Yield Corporate Bond ETF. 

“Powell: asset purchases are an important piece of the accommodative policy stance. The asset purchase program is doing a lot of good.”

Retail investors, on the other hand, were investing in equity ETFs, like SPY, the SPDR S&P 500 ETF, Vanguard's S&P 500 ETF, and the Vanguard Total Stock Market Index ETF. This shows that investors were able to successfully source liquidity to adjust their portfolios across both equities and fixed income. Most importantly, 69% of global ETF investors plan to increase their ETF allocation in the next 12 months and 62% of US investors plan to increase their exposure to actively-managed ETFs, an increase of 10 percentage points from 2019.

How investors choose ETFs to invest?

Long story short, the most important consideration for ETF investors are historical performance (past performance is no guarantee of future results) and expense ratio. It is crucial to understand the real costs of buying ETFs. Don’t forget there is nothing free in this world and if you see an advertisement like “no commission for operating”, you could later receive a management fee. Also, take into account the spread between the bid and ask prices on smaller funds as the spread represents a cost that you will have to pay to buy or sell a fund.

Finally, I would like to mention some of the most curious ETFs you might have never heard about.

Remember: Do not invest in something that you do not understand and check whether the ETF you chose fits your risk profile.

1. iShares J.P. Morgan EM High Yield Bond ETF (EMHY) – it tracks the performance of below-investment-grade U.S. dollar-denominated, emerging market fixed and floating-rate debt securities issued by corporate, sovereign, and quasi-sovereign entities. In terms of low-interest rates, many investors began buying junk bonds in a hunt for returns.
   
2. NERD Esports ETF – designed to track the performance of the growing market of electronic sports, or “esports”. Overall, the index includes video game publishers, streaming network operators, and hardware companies that have established themselves as key players in the esports, or electronic sports, industry.
   
   A similar ETF could be the VanEck Vectors Video Gaming and Esports ETF (ESPO).
   
3. JO US ETF – tracks a single coffee futures contract at a time, purchased two or three months out, and held until the month of maturity. A problem is that this ETN exposes investors to credit risk, and follows a futures-based index that may lag behind a hypothetical return on spot coffee prices.
   
4. COW US ETF – offers exposure to companies involved in the production of agricultural products, fertilizers and agricultural chemicals, farm machinery, and packaged foods and meats.
   
5. iShares Global Clean Energy – monitors the dynamics of the S&P Global Clean Energy Index. Shares of US and international companies included in the index are purchased in equal proportions in the structure of the largest ETF in its segment. Companies of all sizes are involved in wind power, solar power, and other renewable sources.

Disclosure: the information contained herein is provided solely for informational and discussion purposes only and is not, and may not be relied on in any manner as legal, tax, or investment advice or as an offer to sell or a solicitation of an offer to buy an interest in any fund or asset.