It was 25 years ago that the world of investment and funds in Europe experienced a revolution, with the arrival of the continent’s first exchange- traded funds (ETFs). The choice available now is staggering and, as with all transformative changes, there is a mix of hype, extremely useful stuff, and frankly, scary elements. I wrote my first book about ETFs for the FT back in 2009. Even I find the pace of change incredible.
The story began on April 11 2000, with the listing on the Deutsche Börse of the LDRS DJ Stoxx 50 and LDRS DJ Euro Stoxx 50, sponsored by Merrill Lynch. Shortly after, on April 28 2000, the iShares FTSE 100 ETF was listed on the London Stock Exchange.
In the intervening quarter century, ETFs have had a huge impact on the European market. In March 2025, net inflows into European ETFs amounted to £28.63bn, bringing the year-to-date total to £99bn. This represented the second-highest net inflows ever for the first quarter of a year and the 30th consecutive month of net inflows. By the end of March, total investment in the European ETF industry had reached £2.4tn. The industry now consists of 3,176 products, with 13,378 listings from 124 providers across 29 exchanges in 24 countries. The value of ETF trading in Europe regularly surpasses £5bn a day.
The most significant improvement has been a massive increase in choice alongside a huge reduction in costs for tracking key markets. For someone who wants to track global equities, there are now just under 400 ETFs that track an ever-increasing number of global equity indices. There is an endless list of funds focusing on areas such as value shares, emerging markets, mature markets and companies with strong records on environmental, social and governance issues. The great majority of ETFs with significant assets under management in this category now offer a total expense ratio (TER) of 0.2 per cent or less.
In this broad global equities bucket, 18 funds track arguably the most popular index, the MSCI World. Very few charge more than 0.2 per cent. As for US equities, 307 ETFs track indices as varied as the S&P 500 and the Nasdaq 100. At least 20 London-listed ETFs track the popular S&P 500 in dollars, with TERs usually 0.1 per cent or less. For anyone seeking an S&P 500 tracker that is sterling hedged, then there are more than 10 listed funds with TERs usually not much above 0.1 per cent. Finally, there are 45 UK equity trackers with combined assets of more than £30bn, with 11 FTSE 100 trackers alone. The TERs for these UK-focused instruments rarely budge above 0.1 per cent.
What are some sensible ground rules amid this cornucopia of choice? My first advice is to choose a target asset class and then decide if an index tracker is the right instrument. There are many assets for which I would avoid using ETFs, ranging from private assets to most Japanese equities. That group certainly includes small-cap equities from anywhere.
Somewhat controversially, I am also sceptical that it is sensible for investors to have put £30bn into UK equity trackers. UK equity indices track changes in the UK economy poorly. They are also highly influenced by sector biases — for example, there are too many resource companies in the FTSE 100.
My next step is rather tedious — understanding which benchmark to track. A huge number of investors believe it is sensible to track the US equity market through the Dow Jones Industrial Average or Japan’s market through the Nikkei 225. Unlike other well-known indices, these two give no extra weight to companies with larger market capitalisations. Many experts consider them to be surprisingly inefficient benchmarks as a result.
Most sensible individuals opt for the S&P 500. But, for anyone seeking more exposure to technology stocks, the Nasdaq might be a better choice. A truly radical option, meanwhile, might be to consider an index that tracks US equities with equal weighting across the smallest and largest stocks in the S&P 500. That strategy has proved fruitful over many years, aside from the last few when the Magnificent Seven of big technology stocks dominated.
My next suggestion is to think about whether to add a twist or an angle to the chosen asset class or benchmark. A cautious type who thinks too many shares are overvalued might prefer a tilt towards, say, value — or cheap — stocks. A value index of US equities or even global equities offers that. In fixed income, I would suggest considering an active ETF. That might sound strange. ETFs normally track an index passively. But a growing number, while they might use an index as a reference point, actively tilt the portfolio one way or another. In fixed income, given the worries about long duration bonds in a world of higher rates for longer and big public sector deficits, I suspect having active portfolio management of, say, US debt or corporate credit might make a lot of sense.
Most ETF experts constantly bang on about cost as the next big issue. Costs really do matter — and the good news is that TERs have been steadily falling. But the biggest funds always have an advantage in cost comparisons because of scale.
Yet I would argue that sometimes the very biggest, cheapest funds are not the best. For example, some ETFs have useful extra features like currency hedging, which eliminates the currency risk. These tend to cost more to run. But in the case of, say, Japanese equities, they can be a lifesaver. Other ETFs choose more specialist index benchmarks, for example, value indices or the S&P 500 equally weighted.
There are also distinctions between “synthetic” ETFs and those that are physically backed, meaning the manager physically buys all the stocks in the index, mirroring it. In a synthetic ETF, a bank, in effect, issues an IOU saying it will pay the return on the index. As collateral, it will offer up all kinds of stocks to make sure the manager is made whole. Although hugely unpopular with many professional investors, synthetic ETFs can make a great deal of sense in assets such as emerging market equities where trading the shares is, to put it mildly, tricky.
It is well worth thinking about the choice between income and total return. The choice is between an ETF that pays out the dividends — or coupons — and one that allows the income to accumulate as a total return.
There is a final point — also related to income — to consider. As the ETF industry has boomed over the past 25 years, there has been a significant amount of clever, and not so clever, innovation. In the past year or so, ETF issuers have concentrated on providing numerous income alternatives. These include active bond ETFs and a tracker that follows the gold price while generating income from selling upside options. The gold price tracker is currently yielding a 12 per cent return.
However, the single most significant innovation has been the relentless rise of money market ETFs that track overnight rates for cash, alongside ultra-short duration bond funds that in effect offer a somewhat riskier take on cash rates. These funds all provide a cheap and safe way of holding cash while generating income. They are not bold for sure but are an essential tool in any investor’s toolkit.
For anyone seeking something much more adventurous, my bet would be on the multi-decade boom in defence spending in Europe and the fast-approaching inflection point in robotics thanks to Chinese innovators.
Both these phenomena can easily be accessed through thematic ETFs that resemble concentrated stockpicker funds. Such ETFs are unpopular with many professionals. But, every now and then, as the success of artificial intelligence stocks has shown, a focused bet on a handful of stocks can yield substantial returns.
David Stevenson is an active private investor. Email: adventurous@ft.com. X: @advinvestor
https://www.ft.com/content/4d6e1dae-41f3-4229-8f71-6c65934ed796
