Who Invented ETFs? The History of the First Funds

Exchange Traded Funds, commonly known as ETFs, represent a popular investment vehicle designed to track an index, commodity, or basket of assets. These funds trade on stock exchanges throughout the day, much like individual stocks. While ETFs are now a widely adopted component of many investment portfolios, their origins are rooted in specific financial innovations and market demands that emerged decades ago.

The Genesis of Exchange Traded Funds

Before ETFs, mutual funds were the primary way for investors to gain diversified exposure to various asset classes or market indices. However, mutual funds presented certain limitations, such as pricing only once per day at the close of trading, restricting intraday liquidity. Investors in mutual funds could also incur tax liabilities from capital gains distributions, even if they did not sell their shares, due to the fund’s internal buying and selling of securities.

The growing interest in passive investing and the desire to track broad market indices more efficiently highlighted these limitations. Financial innovators began to explore concepts for a new type of fund that could offer the diversification of a mutual fund with the trading flexibility of a stock. This conceptual groundwork laid the foundation for a product that could address the need for continuous trading and more tax-efficient exposure to market benchmarks.

The Pioneering Products and Their Creators

The earliest form of a publicly traded index fund emerged in Canada with the launch of the Toronto 35 Index Participation Fund (TIPs) in 1990. This product allowed investors to gain exposure to the TSE 35 Index. Its introduction demonstrated the viability of a fund that could be bought and sold throughout the trading day.

The first true exchange-traded fund in the United States, the SPDR S&P 500 (ticker: SPY), launched in January 1993. Often referred to as “Spiders,” this fund was created by State Street Global Advisors in collaboration with the American Stock Exchange (AMEX). Nathan Most, then an executive at AMEX, played a significant role in its development. SPY was designed to track the performance of the S&P 500 index, providing investors a simple way to invest in the broader U.S. stock market.

Early Adoption and Market Impact

Following the introduction of SPY, the concept of exchange-traded funds gained traction. Investors recognized the advantages of intraday trading capabilities, allowing for greater flexibility in managing positions. The structure also offered tax efficiencies, as capital gains distributions to shareholders were often minimized due to the creation and redemption process involving in-kind transfers of securities.

The success of SPY paved the way for other index-tracking ETFs. For example, the Nasdaq 100 Index Tracking Stock (QQQ), often called “Cubes,” launched in 1999 to track the Nasdaq 100 Index. Similarly, the Diamonds Trust (DIA), tracking the Dow Jones Industrial Average, debuted in 1998. These early products expanded the range of market segments investors could access through the ETF structure, laying the groundwork for the diverse and extensive ETF market today.