by Nate Geraci
The ETF revolution and recent developments
“ETFs are fundamentally a technology. They are mechanisms to achieve a certain goal, like phones. Traditional mutual funds were rotary phones. ETFs are smartphones: They do the same thing but are in a better package.” – Dave Nadig, Managing Director of ETF.com.
ETFs are the technology revolutionizing investing. ETFs are democratizing access to strategies and financial markets investors could not have dreamed of even a decade ago.
Just last year, we saw the launch of a physically-backed gold ETF in which the gold is guaranteed by a sovereign entity, an S&P 500 bond ETF, an artificial intelligence-powered international equity ETF, and a 90% equity/60% U.S. Treasury ETF conceived through a Twitter conversation. There is a reverse market cap weighted ETF which flips the S&P 500 on its head, an ETF using a machine-learning algorithm to invest in the highest beta stocks, and even an ETF designed to offer exposure to the ETF industry itself.
The sheer entrepreneurial spirit in the ETF ecosystem is staggering. This is why the industry draws comparisons to Silicon Valley. A culture of innovation and passion has sprung to life around the ETF technology.
"ETFs are transforming the investment landscape and ultimately advancing investor interests. Just as we expect our car and phone technology to evolve, we should want and expect the same from our investments."
The beneficiaries are investors, who continually receive the latest investment tools to help navigate today’s increasingly complex global financial markets. Remarkably, these tools are often provided in a low-cost and tax-efficient manner.
There is a level of transparency not typically associated with competitive innovation (in which creators usually like to keep their proprietary methods closely guarded). Portfolios can be constructed in a multitude of ways. Every investor has an opportunity to seek new and varying patterns of returns.
The challenges of innovation; the dangers of ETFs
However, game-changing innovation is not without its challenges. Consider ethical dilemmas posed when developers program self-driving Teslas (avoid hitting a pedestrian at the risk of killing the driver?), mental health and addiction concerns over excessive iPhone use, and obvious safety concerns over private space travel. ETF innovation is no different.
The latest investment technology can be downright dangerous if used improperly. Portfolio damage can be inflicted in a multitude of ways. Risks must be measured against potential upside. The ETF movement has progressed in such swift fashion that there is now a dizzying array of options available. Investors must separate the wheat from the chaff. Doing your homework is now more important than ever. ETF due diligence is a must.
While the risks posed and additional work required by ETF innovation is not insubstantial, that should not detract from the bigger picture.
ETFs are transforming the investment landscape and ultimately advancing investor interests. Just as we expect our car and phone technology to evolve, we should want and expect the same from our investments. Otherwise, we would all still drive Ford Model Ts down to our local broker’s office for the privilege of paying abhorrent fees to invest in loaded actively managed mutual funds owning the ‘Nifty Fifty’ stocks. The broker would then dial us on our rotary phones to sell us another fund, interrupting our pleasant evening of watching black & white TV.
Understanding ETFs as the key concept for beginning to invest
The key to understanding new technologies often involve a learning curve and will not be a fit for everyone. You wouldn’t use Tesla’s Autopilot mode without understanding the nuances of operating it; the same should hold true for more sophisticated ETFs. Not everyone should be lined-up to venture into outer space; this is the same for pioneering ETF strategies.
"Doing your homework is now more important than ever. ETF due diligence is a must."
Ironically, perhaps the best way to embrace ETF innovation is to remember some old investment wisdom: ‘if you don’t understand it, don’t invest in it.’
Nate Geraci is co-founder and president at The ETF Store and host of the podcast, ETF Prime. He can be found tweeting here: @nategeraci
This article was originally written for and published on Inside ETFs 365 here.