The Triumph of Transparency

One of the best, ongoing success stories in the investment world is ETFs. At a time when Wall Street is under fire for creating opaquely complex products that even sophisticated investors didn’t fully understand, the unpretentious ETF continues to both attract assets and innovate, without straying from its heritage. The reason? Call it, the triumph of transparency.

ETFs inherently provide a level of portfolio transparency above and beyond nearly any other packaged investment product, especially in relation to their close counterparts — mutual funds. The majority of ETFs disclose their portfolio holdings at the end of each trading day. In contrast, mutual funds do so quarterly.

This means ETF investors are uniquely able to ascertain their exposure to a particular company or sector “on demand.” Consider the situation many investors faced during the financial crisis – mutual fund holders wondered if their 401(k)s and IRAs were invested in the likes of Lehman Brothers and Bear Stearns, whereas ETF investors had daily access to this critical information, allowing them to make instant, informed decisions about how to protect their assets. Institutional investors, too, have found ETFs a worthy tool – because of ETFs’ portfolio transparency, traders are able to use them as a means for capitalizing on, or hedging against, broad movements in different areas of the stock and bond markets on a daily basis.

If there’s any doubt as to transparency’s effects, consider the rapid growth of ETFs since their inception in 1993. Today over 1,000 ETFs are available to investors, with total net assets exceeding $800 billion. That compares with 80 funds containing around $66 billion at year-end 2000, according to the Investment Company Institute.

Still, there is plenty of room for growth. Roughly 2% of U.S. households, or 2.3 million, owned ETFs in 2008. Opportunity abounds for asset management firms to bring their own unique vision and strategies to the ETF market.

Why We Need Transparency

Beyond the clear structural benefits of transparency for investors, there is a broader case to be made for transparent portfolios – for more information, more frequently – as the financial industry works to rebuild in a post-crisis era.

Transparency, at its most basic level, builds trust. Asset management firms that empower investors with unvarnished information send an important message: “We have nothing to hide, and we have an interest in our investors knowing what they hold.”

Building a culture of transparency makes for both a profitable business model and a stronger investment industry overall – an industry that can survive, thrive and innovate during the market cycles that will inevitably push investors from irrational exuberance, to fear, to renewed optimism.  The success of ETFs to date is a clear indicator of how transparency and its backers can triumph in the new investment world of today, and tomorrow.