ETFs Take Center Stage

04/01/2009 12:00 pm EST

Focus: ETFS

Peter Way

Founder and CIO, Peter Way Associates

Peter F. Way, editor of Block Traders' ETF Monitor, says exchange traded funds are becoming a bigger part of daily trading because of their transparency and efficiency.

You may not be aware of it, few are, but of late there is more trading volume going on daily in ETFs than in individual stocks. The 800-plus exchange traded funds are taking on a new dominant role in both personal and professional money management, approaching a half trillion dollars invested.

The ETF transaction volume is concentrated in 120-150 issues that trade over a million shares a day. The biggest funds are the Standard & Poor's 500 index trackers SPY and IVV, with a combined investment of $75 billion and daily trade combined volumes of 27 million shares.

Second place in size, and the most rapidly growing group is the SPDR Gold Shares (NYSEArca: GLD), which has attracted $32 billion and trades 20 million shares a day. A second gold ETF, Market Vectors Gold Miners (NYSEArca: GDX) holds about $4 billion and trades ten million shares a day.

Well, so what? Mutual funds hold trillions of [dollars in] equity investment, and trading volume in their shares never seems to make the TV evening news. Of course, that's just the way the mutual fund industry wants it.

The big deal is that the nature of professional money management is changing dramatically. And astute individual investors are changing right along with it. The appeal of any fund, mutual or exchange traded, is in the instant diversification of a prepackaged selection of stocks.

The mutual funds suggest that they offer continuous management of that selection process so that the investor does not need to do anything but provide the capital. But the reality is that most heavily promoted mutual funds are too big to do much more than nudge their holdings around, and their competitive concerns urge them to conceal what they are doing as long as they can. The investor only comes to realize what he or she is invested in many months after the fact.

Until ETFs came along, investors were stuck. They either used mutual funds, or like the professionals, built their own diversified portfolios out of individual stocks. That's a laborious and time-consuming process needing constant maintenance, monitoring diversification, and valuation balances.

Now, with ETFs providing both the prepackaging diversification and clear transparency of holdings, there is less need [in institutions] for the stock-by-stock expertise of expensive analysts. Economies of operation are attractive.

The emphasis is shifting in professional circles to portfolio strategists who seek to tailor the holdings of the portfolio to meet the assigned "mandate" or objective of the investor. What results is a sort of "fund of funds" portfolio. That is made to order for the efficiencies of ETFs.

When the character of the investment market changes, going from strength and confidence to weakness and concern, all investors need to adapt and meet the new challenge. ETFs make those adaptations much easier because their holdings, being clearly known, are much more susceptible to forecasting.

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