The 25-eventful years of ETFs

Exchange Traded Funds (ETFs), which recently completed its 25 year of existence has seen remarkable growth since their launch. ETF’s Asset under management (AUM) and trading is now even bigger than USA GDP. But very few people would know that the origin of ETFs can be traced back to the report by Securities and Exchange Commission (SEC), US market regulator. The report titled “The October 1987 Market Break’ was an investigation report on Dow Jones Industrial Average (DJIA) steep fall of 508 points or 22 per cent in a single day on October 19, 1987, which till date remains the single biggest fall and is better known as ‘Black Monday’. This report diagnosed the reason for the fall as ‘portfolio insurance’ and also accidentally suggested the product idea of ETF.

The report recommended an alternative approach where a well-capitalized and supplementary market maker could have turned to a single product for trading baskets of stocks, which would have made the fall less drastic and smaller. The idea was picked up by the product development team of American Stock Exchange (AMEX), who were desperately looking for ideas to attract institutional investors. AMEX, which was once the dominant exchange in US, was lagging New York Stock Exchange (NYSE) and Nasdaq in equity trading. To keep their relevance, in 1993, AMEX came out with the first ever ETF in US, the Standard & Poor's Depository Receipts (SPDR) focused on investing in the Standard & Poor's (S&P) 500 Index, which till date remains the largest ETF in terms of asset under management (AUM). Now, AMEX is a part of NYSE Euronext.

The twist in a tale is that the prescription of ETF to contain big market fall is now becoming a disease in itself. They are becoming an increasing concern to regulators elsewhere. Last year, for instance, a major fall in S&P 500 was traced back to involvement of ETFs.

Back home in India, first ETF was launched in year 2001, however, they are yet to catch the fancy of investors. This is despite the bigger institutions like Employees Provident Fund Organization (EPFO) committing huge investments into ETFs. Besides governments are also promoting it in a big way. Currently, AUM under ETFs form mere 3 per cent of total AUM. ETFs can be used by entire range of investors right from naïve investors to institutional investors. Hence, going forward as markets and investors mature, we may see rise in ETF investments.