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Here’s Why ETFs are Booming

Trading ETFs
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Exchange Traded Funds (ETFs) are fast emerging as one of the most popular options, with both retail and institutional investors piling into this investment vehicle. Data from State Street Global Advisors reveals that ETFs topped $464 billion in 2017, which is indeed proof of how investors are favouring ETFs over other investment vehicles. However, a Credit Suisse report, which covered 2017 through November, states that mutual funds registered inflows of only $91 billion. Some data is even more stunning. Data from research firm ETFGI shows that $4.56 trillion were invested in ETF assets in 2017 as against $3.39 in 2016, indicating that the ETF universe has grown by more than a trillion dollars in less than a year.

ETFs have become the primary choice for portfolio allocation across the retail and institutional segments. An increasing number of investors are increasingly migrating to Exchange Traded Funds largely because of the lure of their low-cost advantages, transparency, and liquidity compared with the traditional actively managed funds. Passive investing, which comprises using funds that track indices such as S&P 500 and Dow Industrials and many other trackers, has increased over the past decades. Although ETFs have been in existence since the late nineties, their popularity has increased since 2008 in the wake of the global financial crisis that saw the global stock markets plummet. 2017 has been a particularly rewarding year for ETFs, with their growth accelerating markedly.

ETFs are baskets of assets comprising stocks, commodities or bonds that are managed passively by a trust company and are traded on a stock exchange. Unlike mutual funds, ETFs offer the flexibility to trade intraday, just like one can trade shares on a stock exchange. Hence, they are called exchange traded funds. This means that ETFs give investors all the features of stock trading such as limit orders, margin trading, short selling, and options. This essentially turns the entire market into a single trading entity. An investor can take advantage of market trends by speculating on the rise in an index, buying an ETF that mirrors this, and sell the ETF before the close of the day. This works out as a unique advantage for ETFs because mutual funds are locked in during trading hours and are priced only at the close of the market. Furthermore, mutual funds require a minimum investment that could mean thousands of dollars whereas an ETF can be purchased for the price of a single share.

According to Canadian ETF strategist Rebecca Chesworth, the reason for the explosive growth in ETFs is a long-term cause that entails a structural change. More investors are choosing ETFs because there is a learning curve during which they discover and learn about the advantages ETFs offer over mutual funds, which allows them to change their investing strategy and behaviour.

The internet also has a role to play here. The ubiquity of the internet has made dissemination of information easy. The tech-savvy younger generation is the new cohort that finds ETFs attractive. According to a Charles Schwab report, millennials are unloading their individual stocks and embracing ETFs. The report states that 9 out of 10 millennials consider ETFs as strategic to their investment plans. With 32% respondents stating that they had replaced all their stock with mutual funds, the biggest revelation from this survey is that the surge in popularity of ETFs is coming at the expense of not just mutual funds but also individual stocks.

The popularity of ETFs indeed reflects the ongoing shift toward passive investment products. The trend has gained steam and 2018 could well be the year when ETFs hit the tipping point.

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