BOSTON (AP) — The growth of exchange-traded funds has been explosive. Over their 18-year history, they’ve become popular trading tools for hedge funds, pension funds and college endowments. ETFs account for around one-third of trading volume on U.S. stock exchanges, and hold nearly $1 trillion.
Yet there’s a piece of prime real estate where ETFs are still trying to gain a foothold: the average investor’s portfolio. The industry is ramping up its campaign to convince Main Street that ETFs deserve a role alongside mutual funds in building up savings for retirement.
Several new ETFs are designed to appeal to buy-and-hold investors. The launches expand the ranks of ETFs that try to take the edge off market volatility, or invest in solid dividend-paying stocks — strategies with big appeal now. Other new ETFs are moving beyond their traditional approach of tracking a broad stock index like the Standard & Poor’s 500. Many use formulas to screen for the lowest-volatility stocks or the highest dividend payers, without the cost of having pros pick investments.
ETFs are now “delivering an investment strategy, rather than just replicating a benchmark,” says Ryan Issakainen, ETF strategist with First Trust, an ETF sponsor that has recently seen strong asset growth from a dividend stock ETF.
But most investors know little about ETFs, which are similar to index mutual funds. Both seek to match rather than beat the market by investing in a basket of stocks or bonds. Fees are typically low because investors aren’t paying managers to pick investments. A distinct feature is that ETFs can be traded throughout the day like stocks, unlike mutual funds that are priced only at the close of daily trading.
It wasn’t until the past decade that ETFs began to gain traction with do-it-yourself investors and their financial advisers.
ETFs have recently begun to appear in 529 college-savings plans and 401(k)s, and they continue to draw stock investors at the expense of mutual funds. U.S. stock ETFs have attracted nearly $63 billion in net deposits since January 2010, while a net $112 billion was withdrawn from stock mutual funds, according to Morningstar.
There’s a dearth of data on how much of the current $970 billion in ETF assets is invested directly by individuals, versus ETFs in portfolios constructed by advisers, or in pension or hedge funds. But professional money managers continue to drive trading of the 1,100 ETFs investors can choose from.
One reason is that many ETFs track such narrow market segments that they’re unsuitable for average investors. There are ETFs that invest in the stocks of small countries like Norway and Singapore. There are also narrow industry options, for instance newly launched ETFs that specialize in natural gas futures.
But there’s a growing number of ETFs with the potential for much broader appeal. Here’s a look at recent efforts by big industry names to attract individual investors:
— Reduce volatility:
The biggest ETF sponsor, iShares, has debuted four ETFs that strive to limit volatility. Each uses screening criteria to select those stocks within an index whose prices tend to bounce around less than others. The new ETFs invest in stock indexes covering the U.S., the global markets, developed nations overseas, and emerging markets. Another sponsor, Russell Investments, launched a similar group of ETFs in May. The products are directed at investors who’ve found it hard to deal with the spike in market volatility since 2008.
— Seek dividend income:
Charles Schwab last month introduced its U.S. Dividend Equity ETF (SCHD). It’s the cheapest ETF among its peers using a dividend stock strategy, with a 0.17 percent expense ratio. The ETF invests in an index of 100 stocks with strong dividend records that are deemed strong based on financial ratios that the stocks must maintain to be in the index. Dividend stocks have been among the market’s strongest performers recently, and are particularly appealing to retirees needing steady income.
— Go with bonds:
About two-thirds of ETF assets are invested in stocks, but bond ETFs have recently grown at a faster pace. That growth could accelerate with the launch of an ETF version of the world’s largest mutual fund, Pimco Total Return, run by star bond trader Bill Gross. Pimco filed papers in April, but the launch date remains uncertain pending a regulatory review.
With $244 billion in assets, Pimco Total Return is commonly found in 401(k) plans. The portfolios of the ETF and mutual fund versions won’t be identical. For example, the ETF won’t invest in derivatives, investments such as futures and options whose value is linked to the performance of another security. The mutual fund often uses derivatives as a hedging tool to reduce risk. Still individual investors might be tempted by the lower expense ratio of 0.55 percent for the ETF compared with 0.90 percent for the mutual fund. Charles Schwab, meanwhile, launched a bond ETF in July, U.S. Aggregate Bond (SCHZ). It invests in investment-grade, taxable U.S. bonds and charges just 0.10 percent.
— Choose an ETF share:
Vanguard is the nation’s largest fund company, and continues to expand its share of the ETF market, where it ranks third behind iShares and State Street’s “SPDRs” ETFs. Last year, Vanguard launched 19 first-of-their-kind funds. Like most mutual funds, they’re offered in different share classes, differentiating the minimum investment required. But they also include a novel ETF share class.
Whether an investor is in a mutual fund share class or an ETF share class, the fund holds the same underlying investments. But other aspects differ, such as expenses, and the opportunity an ETF affords to trade at intraday market prices. Vanguard has a patent on the structure, and continues to announce more launches of funds with ETF shares. The latest came this week, when Vanguard announced plans for two new two funds that will invest in foreign bonds. The launches are expected in early next year.
Questions? E-mail investorinsight(at)ap.org