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What is Direct Indexing and Why You Should Care

Traders Magazine Online News, May 16, 2018

BRI Partners

ETFs: the original innovation

When State Street launched the SPDR S&P 500 exchange traded fund (ETF) in 1993 it would mark the beginning one of the most innovative disruptions on Wall St.  ETFs offered the ability to trade a diverse basket of stocks, through a single exchange traded vehicle on an intraday basis.  While the idea itself was not new (Canada had already launched an ETF at few years prior and the indexing mutual funds had been around for awhile), the SPY ETF was so simple and easy to own.  This was a time when the internet was still new and most investors were used to brokerage accounts that required a phone call and had ticket charges of $15.  The ability to click a button and be able to own a proportional share of the S&P 500 in a matter of seconds with low dollar amounts and low transaction costs was a big deal for retail investors.

To say it was revolutionary is an understatement.  The cheap and easy diversification afforded by ETFs democratized the investing landscape for investors. This ushered in an entirely new era of investing which would, not only reduce costs, but also change the perspective of how many would think about investing.  More and more investors would begin to think about investing in exposures and not just individual companies. For these reasons, ETFs were as much a technological innovation as a financial one.

The ETF Revolution and the Rise of Passive

The utility of ETFs was immediately obvious and as investors continued to crave the easy diversification provided by these low-cost, transparent vehicles, Wall St. was eager to fill that demand.  This saw a multi-decade period of proliferation as ETF sponsors realized there was demand for almost any kind of ETF.  Everything from industry sectors to gold mining companies to the various iterations of “Smart Beta” ETFs had a buyer.  The 2008 financial crisis only accelerated this demand as ability of active managers to deliver “alpha” was called into question en masse.  Research even showed that active managers actually added negative alpha during the 2008 crisis[1].  Whatever the reason, 2008 proved a powerful catalyst in the growth of ETFs.  As can be seen in a recent Deutche Bank report, the growth in ETFs (and ETPs[2]) since 2008 has been nothing short of “extraordinary”:

ETFs: Enabling the Robos

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