Before the advent of the ETF, there was no easy way to invest in the Nasdaq composite index. Even when ETFs first were released into the market in 1993, they were primarily for the institutional investor and known only as index shares.
After looking at the Nasdaq composite, John Jacobs, executive vice president of global information services at Nasdaq, and his team determined the Nasdaq-100 would be a more effective index for the first Nasdaq ETF, prompting the 1999 launch of the QQQ and creating a path for retail investors. The fund, also known as the Qs, has since grown to more than $40 billion in assets, and paved the way for the development of today’s ETF industry.
Jacobs retires from Nasdaq in January, but will remain there as a strategic advisor through next year. He reflects on the growth of the ETF industry in a discussion with Money Management Executive and shares his predictions on upcoming evolutionary trends for the products he helped launch.
Describe what ETFs were like when they were introduced?
The U.S. ETF market started over 20 years ago, back in 1993, with the launch of the SPY (SPDR S&P 500 ETF). While there was a similar product before that time in Canada, named TIPS, SPY was undoubtedly the first ETF to become mainstream. At the time, nobody called them ETFs. We just called them index shares. The market was trying to solve a problem that was born out of the market crash of 1987, which was led by program trading, and investors were looking for a way to easily trade a basket of stocks. Over the next six years, a small team at the American Stock Exchange developed a way to do just that, and the precursor to the modern ETF was created.
The ETF you helped create — the “Qs” — has grown to over $40 billion in assets. What’s contributed to its success?
The Qs launched in 1999, and its success was propelled for a few reasons. First, until then, there was no easy way for retail investors to invest in the Nasdaq composite. Every day millions of investors watched the movement of the Nasdaq composite, but couldn’t participate in the trading like they could with other index products. The Qs solved that problem and was the first way for retail investors to invest in Nasdaq stocks through an index fund.
Second, and important to note, was that by 1999, Nasdaq was home to hundreds of public companies. This became an important barometer for the growth of the market and the Qs became a great way to invest in a growth market. Demand was very strong from inception and today, the Qs are the standard for large cap growth. Additionally, we were one of the first smart beta indexes to represent that sector.
What direction do you see the ETF industry headed toward?
I see five major trends:
- ETFs are in the early stages and there is still plenty of room to innovate and grow in the equity markets.
- There is significant growth in sectors such as fixed income, commodities and currencies. These areas have been mostly untouched and we are starting to see some innovative products being introduced from numerous providers.
- The ETF market is mostly confined to the U.S. and Europe. Investors are demanding access to regions such as Asia, Latin America, and the rest of EMEA and you’ll begin to see more and more products created to meet this demand.
- We are seeing a stronger push for non-transparent and active ETFs. I don’t believe that they will attract enough assets to surpass traditional, transparent ETFs, but they will certainly be attractive to fill certain niches in product lineups.
- Finally, ETPs are not yet being utilized in defined benefit plans and defined contribution plans in the U.S. or elsewhere. We are beginning to see some 401(k) providers start to offer access to ETFs; and once they become widely adopted into these plans it will be a tremendous growth opportunity for the industry.
Do you foresee a time soon when ETFs could overtake mutual funds? And if so, when would that happen?
While I’m not sure if ETFs will ever overtake mutual funds, if you look at flows in recent times, it definitely shows asset flows are going faster into passive than active funds. These passive flows include index ETFs as well as mutual funds, and even though I expect growth will continue to be strong in the ETF space, I don’t think investors will ever completely pass on mutual funds.
With so many ETF products on the market, is there a risk of saturation?
I don’t think so. Many investors still have their favorite channels and some investors prefer using investment vehicles offered only by a specific institution. Therefore, there will be room for more than one ETF, tracking the same investment thesis, but coming from different firms.
What was the biggest evolution in the ETF industry that you experienced in your career at Nasdaq?
The biggest evolution came during 1998 and 1999. The first was BGI (currently iShares) launching a family of products to give investors a real choice of how to invest. The next would be when we created and launched the QQQs during the tech boom, which really put ETFs on the map for retail investors. These are the two seminal events that made the ETF market take off like it did. Prior to this they were primarily institutional products.
It appears that you can’t leave the industry completely. You will maintain an advisory role.
While I’m retiring from my current role, I am delighted to continue to serve. I’ve always said that I’m proud to be one of Nasdaq’s first shareholders, and plan to be one for the rest of my life.