Exchange traded funds have been in the market for nearly a quarter-century (born roughly the same year as the World Wide Web). Today, the number and breadth of adopters continue to grow across stock and bond investing. While advisors have long understood and embraced the versatility of ETFs, many professionals find themselves with clients who have questions and possibly misperceptions about ETFs.
As someone who spends his day focused on ETFs, I frequently face questions from skeptics. Here are the challenges I hear most from dissenters and what I tell them to try to reassure them—and even get them excited to consider adding ETFs to their investment toolkit:
1. Aren’t ETFs riskier than other types of investments?
I’m asked this one a lot, usually during and right after a volatile period in the markets. To a large degree, this concern stems from a relative lack of awareness about ETFs.
First let’s start with what an ETF is: a fund that trades like a stock. ETFs typically seek to track an index, providing investors with diversified access to a slice of the market at a low cost. This simple idea has given birth to a $3 trillion global industry (Source: BlackRock, as of June 30, 2015).
Market volatility often leads investors to consider exiting the market. Recent low returns and high volatility make for a more nervous environment for investors, with Brexit as a reminder of how quickly the markets can turn.
But jumping in and out can exact a cost on the bottom line. We know that it’s “time in” rather than “timing” the markets, and that those who ride out the volatility and stay invested are likely to be more successful in meeting long-term goals. For example, a hypothetical investor with a $100,000 portfolio of stocks who tried to time the market and missed as few as the five top-performing days over a 20-year period from Jan. 1, 1996 – Dec. 31, 2015 would have made up to $160,956 less than those who stayed invested for the entire time period. (We calculated this illustration using the S&P 500 as the “market,” and of course future results will differ.)
It’s not that ETFs don’t have risks. They are market instruments, and like stocks, their prices will be affected by a range of factors from interest rates to geopolitics and currency movements. That said, it’s important to remember that these vehicles operate within a well-functioning, well-tested infrastructure with oversight.
In fact, for investors who are inclined to exit the market as a reaction to these types of events, minimum volatility ETFs can provide an investment strategy that can potentially mitigate risk, while keeping them in the market.
2. Why should I bother with ETFs when my active funds are doing just fine?
Here’s why we think ETFs are worth considering alongside your active exposures:
- Most ETFs are constructed to provide a specific exposure to an index. This means that the focus of their exposures will not change over time. There’s no risk of “style drift,” in other words. ETFs seek to do what they say on the label, which provides investors with clarity when building a portfolio and seeking diversification.
- Costs matter, particularly over time, and particularly in an environment where every penny counts. ETFs can help you keep more of what you earn. The savings from using ETFs can be substantial, both at your core and in other investment strategies where active fees can erode portfolio returns over time.
- ETFs are easily accessible for all types of investors.
They’re also versatile. How you incorporate ETFs into a portfolio will depend on your own investment approach.
3. Aren’t these primarily niche products?
Far from being niche products, the majority of ETFs seek to track broad and liquid markets: U.S. stocks and bonds, and international and emerging markets stocks. For example, as of June 30, iShares Core suite managed more than $265 billion in assets globally.
And yes, ETFs can also provide access to more specialized markets. Our industry is always innovating to provide investors with a full range of the choices that they’re looking for. Twenty years ago, it was the S&P 500 Index and single country funds; today it is bonds, smart beta and currency hedged funds.
The dynamic nature of the vehicle is why more investors than ever are turning to them—and turning skeptics into ETF investors.
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Martin Small is BlackRock's Head of U.S. iShares. He is responsible for directing strategy and leading U.S. regional activities across multiple functions for the exchange-traded products business, including sales, product management and development, marketing and communications, capital markets and the operating platform. He is a member of BlackRock's Global Operating Committee and the iShares Global Executive Committee.
Buying and selling shares of ETFs will result in brokerage commissions. The strategies discussed are strictly for illustrative and educational purposes and are not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. There is no guarantee that any strategies discussed will be effective.
Active funds typically charge higher fees than index-linked products due to increased trading and research expenses that may be incurred. Index funds are not actively managed and will not attempt to take defensive positions under any market conditions, including declining markets. For more information about the differences between ETFs and mutual funds, click here.
The iShares Funds are distributed by BlackRock Investments, LLC (together with its affiliates, “BlackRock”). iS-18761