When I wrote ETF Trading Strategies Revealed in 2006 I said that ETFs would explode in popularity. That has happened. There are now 6,500 ETFs with assets totaling $6 trillion. Money is flowing into ETFs because of their low fees, strong performance, and unique characteristics.

More money is invested in ETFs than hedge funds. Hedge fund fees are typically “2 and 20.”  That means two percent of assets and 20 percent of yearly profits. A fund manager must be extremely good to offset those high fees. Most haven’t been. S&P 500 index ETFs, along with their extraordinarily low fees, have performed better.

Interestingly, there are niche ETFs that attempt to mimic hedge funds. AlphaClone Alternative Alpha (ALFA) and Global X Top Guru Index (GURU) track the biggest holdings in the better-performing hedge funds. Both are outperforming the S&P 500 this year.

Some quantitative ETFs are becoming popular. Two examples are Invesco S&P 500 Value with Momentum (SPVM) and Invesco RAFI Strategic US (IUS). SPVM has a mathematical model that selects 100 large-company stocks that have high “value scores” and “momentum scores.”  IUS selects securities using a model that uses fundamental data, such as sales, operating cash flow, return of capital, and book value. 

Another niche category is long/short. These ETFs attempt to reduce risk by establishing both long and short equity positions. That way when the market goes up the long positions do well and when the market falls the short positions do well. Performance of this category has been mixed at best.

Not all ETFs become popular. ETFs that don’t gather assets don’t last long. This year, 1000 ETFs closed their doors. Those ETFs were thinly traded. Some, like Legg Mason US Diversified Core, are broad-based. Unfortunately for them, there are a lot of available core ETFs. Most are very narrow, such as the Global X Fishing ETF. Although there is no risk to the investor when a fund closes, the liquidation is a taxable event if the ETF is held outside of an IRA.   

ETF assets will continue to rise, with the bull market acting as a tailwind. Successful new niche players will be introduced but launching an ETF that attracts assets is becoming increasingly difficult. The ETF market is maturing, which is why so many are shuttering. That is good for the industry, and good for investors, too.