The Exchange-Traded Funds Manual, Second Edition

CHAPTER 1

An Introduction to Exchange-Traded Funds

EXCHANGE-TRADED FUNDS WERE INTRODUCED AS “SOMETHING TO TRADE”

Many of mankind’s great innovations owe at least some of their success to serendipity. A popular legend suggests that serendipity helped mankind learn the usefulness of fire. As the story goes, one of our ancestors came upon the site of a fire that had been started by lightning. This early human discovered that the fire had burned an animal’s carcass. The “cooked” meat tasted better than raw meat, and men soon learned that cooking enabled humans to obtain nutrition more efficiently, freeing up time and providing energy for other pursuits.¹ This kind of serendipity has been a common theme in many of mankind’s endeavors.

One of the best examples of serendipity in the financial markets—from several angles—is the early development of exchange-traded funds (ETFs). In attributing some features of exchange-traded funds to serendipity, we certainly do not mean to minimize the role of the developers of the early exchange-traded funds. They deserve full credit for the wisdom they displayed in designing the early ETFs introduced in Canada and the United States. Although it is not fashionable to credit regulators with a positive role in financial product development, regulators were almost certainly responsible for some of the shareholder protection features of ETFs. Human efforts notwithstanding, however, some key features became part of the ETF by accident. The features of ...