What are ETFs, you say? Exchange-traded funds. They have some of the characteristics of mutual funds, representing the combined value of an entire basket of stocks -- or sometimes as little as a single commodity, such as gold. But, unlike mutual funds -- which are priced only once a day, at the close of the market -- ETFs can be bought and sold at any time of the trading day and can be sold short or optioned.
These qualities make ETFs suited for rapid-fire trading by hedge funds and other high rollers. You may not have heard much about ETFs until now -- but you'll be hearing much more about them soon.
Technology Makes ETFs Tick
A few ETFs, such as those that track the S&P 500, have been around for years. But the speed and power of today's computers are making it ever-easier for investment companies to put together new ETFs that track virtually anything of value that people are willing to bet on.
Harvey Baraban, the CEO from 1978 to 1989 of California's Baraban Securities, says ETFs are growing because they allow hedge funds and other big traders to take a position in hundreds or thousands of stocks simultaneously.
"They can have instant coverage of a particular sector with one click of a mouse," Baraban explains. "That's the way technology has afforded the financial community to have new and very focused products -- you can make an index on almost anything."
If an investment firm, for example, believes investors will be interested in tracking oil shipping companies, it can create an oil-shipping index and start selling a matching ETF. As money flows into and out of the ETF, computers immediately buy and sell the exact number of shares needed to keep the fund equal in value to the index.
Barclays Global -- the Largest in ETFs
The biggest name in ETFs by all accounts is Barclays Global Investors. With offices in the U.S., U.K., Canada, Australia, Singapore, and Hong Kong, Barclays claims to have about a 55 percent share of the American market, with 114 ETFs registered in the U.S. alone.
The speed with which new ETFs attract money is head-turning. This is especially true for the launch of ETFs that represent indexes or baskets of equities that weren't previously tradable with a single buy.
"Our Silver Trust ETF within three weeks attracted $1 billion," says Tom Taggart, managing director of global public relations for Barclays. The ETF tracks the price of silver on the London Bullion Market. For many investors, buying an ETF is preferable to buying silver itself or trying to simulate an investment in silver by purchasing the shares of publicly traded mining companies.
"We've just launched an ETF on the Goldman Sachs Commodity Index," or GSCI, Taggart says. This index would have been impossible to track with a single investment until recently. Barclays' ETF is made up of 24 different futures contracts in such areas as energy, agriculture, and industrial metals. The company's computers keep all these values straight on a minute-by-minute basis so investors only have to follow one number.
Besides the immediacy of ETFs, which trade throughout the market day, they have other advantages over mutual funds, Taggart explains. "If you're buying the Russell 2000" -- a well-known index of small-capitalization companies -- "it's going to stay the same. With mutual funds, you may have style drift." In other words, a market index may change slightly over the course of a year, but a mutual fund's managers may change their minds at any time.
ETF holdings amount to more than $358 billion in the U.S. and $76 billion in Europe, according to figures from State Street Global Advisors. These numbers are certain to grow as more funds are established and investors learn more about them.
Since these funds can be optioned and leveraged, the potential is there for financial debacles if the emerging investment vehicles aren't carefully monitored and regulated. No meltdown is on the horizon -- but overextended markets aren't usually obvious to investors before many find themselves licking their wounds.
For more information, Barclays publishes ETF data sheets at its iShares Web site.