Wall Street's most historic days are imbued with darkness: Black Tuesday shook 1929. Black Monday arrived for 1987. But Friday, Jan. 29, 1993, lacks an appropriate, and, in this case, lighter sobriquet.
That day, 30 years ago, a cartoonishly human-looking spider hung above the floor of the American Stock Exchange in celebration of the first trading day for a most chimeric financial product — Standard and Poor's Depositary Receipts, aka SPDR.
Now known by its ticker, SPY, and since renamed the SPDR S&P 500 ETF Trust, the first exchange-traded fund in the United States was built from the mechanics of stock trading, unit investment trusts and commodities. But that amalgam eventually helped build State Street Global Advisors' SPY into a $360 billion juggernaut and paved the way for a fundamental reshaping of the investment landscape.
From one product and $6.5 million in assets on day one, U.S. exchange-traded products have grown to 3,081 offerings and $6.5 trillion in assets through Dec. 31, 2022, according to FactSet Research Systems Inc. Globally, there were nearly 12,000 products and $9.2 trillion in assets through December 2022, according to London-based research firm ETFGI LLP.
To mark the 30th anniversary of ETFs in the U.S., Pensions & Investments caught up with several longtime industry participants for their insights and observations on what fueled such phenomenal growth.
"The biggest surprise is that it actually worked," said James Ross, then working in fund administration for State Street.
"SPY was built to solve a trading problem, not an investing problem. We didn't even know what problems investors were dealing with."
Mr. Ross, who retired from State Street Global Advisors as chairman of the global SPDR business in March 2020, recalls that the ETF structure — warehousing a basket of stocks in one tradable "security"—was a response to a Securities and Exchange Commission report on the 1987 Black Monday crash that fingered program trading as the initial spark of the sell-off.
"ETFs certainly addressed the problem of the 1987 stock market crash," said Reginald M. Browne, principal at trading firm GTS Securities LLC in New York and a former ETF floor trader. "But regulators and the industry could hardly have predicted the innovation that would come."
The ETF structure consolidated direct exposure to underlying securities, provided an arbitrage incentive for market makers and offered intraday index tradability outside of the futures and options markets.
ETFs now include the global equity, fixed income and commodity markets, not to mention leveraged exposure, currencies, portfolio solutions and even single stocks.
"There is a strong possibility that mutual funds will not exist in 20 years, while ETFs will prevail," Mr. Browne said. Unlike traditional mutual funds, ETFs benefit from externalizing their trading costs through in-kind creation and redemption of fund shares for underlying securities. This mechanism also helps ETFs minimize (or eliminate) the distribution of capital gains for taxable investors.
"The massive growth of ETFs can be boiled down to the many benefits generated by the efficiency and flexibility of their operational structure," said Bruce Bond, co-founder and CEO of Innovator Capital Management LLC and former co-founder and CEO of PowerShares Capital Management, sold in 2006 to what is now known as Invesco Ltd.
"Almost any investment process you can deliver in an ETF is going to improve on the return to investors when compared to legacy investment and fund structures," Mr. Bond said.
Deborah Fuhr, managing partner and founder of research firm ETFGI in London, said she smiles when she thinks about the number of people globally who told her that they saw no use for ETFs or had no interest in them. "Years later, they turn around and launch firms to create ETFs, use ETFs, and then go shout about it," Ms. Fuhr said.
Of course, in the early days of ETFs, they were seen as niche products just for indexers, Mr. Ross said. But interest accelerated coming out of 2001 and 2008, when stock market drops highlighted the underperformance of active management. That same phenomenon occurred after the 2020 sell-off as well.
Over the last three years, U.S. investors have directed $2 trillion into ETFs, including a record $942 billion in 2021, according to FactSet. By comparison, traditional mutual funds experienced $1.6 trillion in net outflows that year, according to the Investment Company Institute.
"ETFs were designed as institutional products, yet the real growth has come from financial advisors and retail investors," said David Nadig, Lenox, Mass.-based financial futurist at VettaFi LLC. "These investors made ETFs a success, not the other way around. They're much, much smarter than they get credit for."
And ETF assets are no longer solely going into indexed products. Actively managed ETFs now account for a third of the U.S. market by products and $351 billion (5%) in assets, according to ETF.com.
Mr. Browne of GTS, who earned the nickname "The Godfather of ETFs" for his trading support and encouragement of new products over the years, credits one of those active managers – Cathie Wood, chief executive officer and chief investment officer of Ark Investment Management LLC—for bringing new investors not just in to ETFs, but into financial markets generally.
"When she first walked into my office in 2013, after leaving AllianceBernstein, I would never have predicted she would have gained the following that she has," Mr. Browne said.
In one telling, the ETF market has been about suspending disbelief from the very beginning.
Mr. Nadig recalled discussions at then-Wells Fargo Nikko Investment Advisors in 1994 prior to the launch of the World Equity Benchmark Series (now iShares country ETFs from BlackRock Inc.). These were the first ETFs to bring exchange-trading of diversified international exposures to the U.S. during market hours.
"Why is anyone going to want to trade Japan when Japan is closed?" he recalled asking.
"Because there will be liquidity," was the reply. Such liquidity would be supplied by market makers, serving as authorized participants able to create or redeem shares of the fund with securities acquired in Japan.
"It took me a solid year or two before I was able to believe that the collective group of actors required to get those first ETFs off the ground were actually willing to put capital behind this seemingly intractable chicken-and-egg problem," Mr. Nadig said. "But they were absolutely right, and I've been trying to catch up ever since."
As for Jan. 29? Let's call it Spdrday.
