ETFs celebrate 20th birthday

In March of 1990, the Toronto 35 Index Participation units (TIPs) were introduced on the Toronto Stock Exchange (TSX). This was the world’s introduction to the Exchange Traded Fund (ETF), a single stock that represents a basket of securities, usually tied to an index.

To give some context to this invention, 20 years later, in March 2010, there were 4,133 ETF listings from 123 providers on 42 exchanges around the world. Total market capitalization of those funds totaled $1.1 trillion.

“We are very proud to have led the world in the creation of this revolutionary investment product,” stated Thomas Kloet, CEO of TMX Group who participated in a TSX market opening ceremony on April 22 in honour of the milestone. “That first listing 20 years ago laid the foundation for the sector’s remarkable growth and innovation – growth and innovation that we plan to foster and support for many years to come.”

ETFs likely owe some of their success to the flexibility and product options they give to the investor. The idea that a buyer could purchase a single unit that represented the value of an entire mutual fund index was truly revolutionary.

“ETFs are usually compared to mutual funds in terms of index-based securities,” said Amelia Nedovich, senior manager, business development, ETFs and structured products at TMX Group. “I think that most of the benefits centre on transparency, cost efficiencies, there are certain tax efficiencies in certain cases, liquidity and the opportunity to diversify.”

“If you’re investing in an ETF, you’re getting the diversification in one equity that in order to match that, you would have to buy several different equities,” she said. “[With ETFs], you can buy the whole basket in one security.”

While Nedovich noted that ETFs really came into their own in the years leading up to 2007, they still continue to grow and change. In 2009, 38 new ETFs were listed on the TSX and as of April 15, 2010, 25 more had already been added bringing the total number of ETFs listed on the TSX to 147.

“What’s happened over the last 20 years is incredible growth in both number of products and trading activity and interest on the part of investors,” said Nedovich. “That I think is largely the result of innovation. Innovation on the part of product providers and innovation on the part of the exchange.”

In a way, ETF have no choice but to constantly change to keep up with consumer and market demands—hence the emphasis on innovation. While the core concept of today’s ETFs remains relatively unchanged from that of the original TIPs, new kinds of ETFs have sprung up over the years to fill the needs of their investors.

“Today, you have the leveraged and the inverse ETF; you have actively managed ETFs; you have sector-rotation ETFs; and you have ETFs that are a combination of pure passive with some active management,” said Nedovich. “So, the industry product has evolved dramatically over the past 20 years but the core passive ETF is similar to what it was 20 years ago.”

From a single offer of participation units in Canada to a trillion-dollar global investment strategy, ETFs have certainly had an interesting ride. The 20-year anniversary of these funds seems an appropriate time to recognize and reflect on this phenomenon.

“I think it’s important to celebrate any great milestone,” said Nedovich. “We were the first, and we’ve seen incredible growth in the industry. So, I think that after 20 years of growth and innovation, there is a due cause for celebration.”