Exchange Traded Funds: A White Paper

By James L. Novakoff, CFP

SUMMARY

• This paper addresses Exchange Traded Funds (ETFs), the index investments that are a cross between exchange listed corporate securities and open-ended mutual funds. ETFs have names such as "Spiders" and "Diamonds".
• While ETFs are now competing with mutual funds, they have a very different history and operational structure. It is important for investors to know the difference between mutual funds and ETFs and few investors fully understand ETFs.
• ETFs are good products and have many advantages over mutual funds – especially in the area of tax control. However, it appears that the ETF will not dominate over mutual funds because these investments also have some advantages.

INTRODUCTION

This paper reviews the history of exchange traded funds (ETFs). ETFs, with names such as Spiders and Diamonds, are investments that are both exchange-listed (like corporate equity securities) and open-ended (continuously offering shares like open-ended mutual funds). This paper also details how these products operate and discusses some of their characteristics.

HISTORY

Supershares

In the November/December 1976 issue of Financial Analysts Journal, Professor Nils Hakansson published a paper titled "The Purchasing Power Fund: A New Kind of Financial Intermediary." The theoretical "Purchasing Power Fund" envisioned a new financial instrument made up of "Supershares" that provided payoffs only for a pre-specified level of market return. The underlying assets of the Purchasing Power Fund were index funds.
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