some of the unique features of ETFs: one of the lowest expense ratios in the industry (Fuhr
(2001), Gastineau (2002), Gastineau (2004a), Gastineau (2004b) and tax-efficiency (Poterba and
Shoven (2002), Gastineau (2004a). The typical expense ratios on an ETF range between 0.35 and
0.50 %, which compares favourably with 0.73 % charged by index funds (Sills (2001), Simon
(2004)). Such low expenses are explained by absence of active management and shareholder-
level accounting. Furthermore, in-kind creation (redemption) gives rise to arbitrage opportunities
and precludes significant deviations between ETF net asset value (NAV) and market price. All
these features render ETFs an attractive investment vehicle.
Thus ETFs have aided in the development of ETF-based portfolio management where
ETFs are used as portfolio components for the purposes of tax management, sector rotation
strategies, hedging strategies, maintaining equity exposure during manager transition etc.
(Gastineau (2004), Chamberlain and Jordan (2004)). The disadvantages of the ETFs lie in the risk
of offsetting potential gains by brokerage commissions paid on every trade, and sensitivity of the
ETF’s price to a price of a single security due to possibility of high portfolio concentration of
particular ETFs (Simon (2004)). In the U.S., first ETFs were introduced on AMEX in 1993 in
forms of SPDRs (Standard & Poors Depository Receipts).1 Since their introduction, ETFs have
seen a remarkable growth; with their assets almost doubling each year since 1995 (see Table 1).
There exists 152 ETFs in the U.S. today, comprising a variety of financial products, such as
SPDRs, iShares, QQQs, VIPERs that are traded on AMEX, NYSE and CBOE (Ross (2005),
Gastineau (2002) and Chamberlain and Jordan (2004)). In December 2004 combined assets of the
U.S. exchange-traded funds amounted to $226 billion, having increased by almost 50 % over the
1 For a brief review of the history of ETFs’ antecedents (portfolio trading, IPS, TIPS, Supershares) see
Gastineau (2002).