Bailey says: "It opened up a lot of potential for research into stock prices. One outcome was academics uncovering that stocks with certain financial characteristics (such as low beta, value, small cap or momentum) provided outperformance over certain periods.
"The big breakthrough came with the French-Fama three-factor model paper in the early 1990s. This eventually resulted in fund houses launching products that tracked stocks with common financial characteristics, often called factors."
Increasing complication
But with increased flexibility also comes increased complication, and ETFs have become ever-more tailored, almost to the point of being extremely selective.
So how did trackers become so complicated? Why do advisers now find themselves explaining concepts such as ESG overlays, smart beta or managed trackers to their clients?
Lamont says the best way to think about funds is to "imagine a spectrum".
He explains: "On one end you have dyed-in-the-wool stock pickers (something close to pure active) and on the other a global tracker fund, which makes no bets against the market (close to pure passive).
"Most new index funds or ETF launches now sit somewhere in between those poles."
This means the benefits of passive funds – transparency and low cost – can be "meshed" with traditional active strategies, he says.
"Because they track a set of investment rules (codified in an index) investors can see what an index fund or ETF holds daily and understand why it is held, which also holds true of more complex indexed strategies.
"Because you are not paying an active manager, even with more complex indexed strategies, this means active bets against the market can be offered at a much cheaper rate."
The immense amount of data on historic stock prices (beyond just the CRSP) has meant researchers and others have been able to study the historic returns of stocks much better, and slice the data in different ways.
This has allowed new indices of different types of stocks to be created – Factor/Smart Beta being the obvious examples. Indices can also be tweaked to match the ethical views of investors, notably the rise of ETFs with ESG overlays.
This is why there are now more indices than individual stocks in the world, Bailey explains.
In 2018, the Investment Association published some data on this and, in 2021, the IA brought ETFs within their purview.
In a statement in 2020, after the market troughs of March when the world plunged into lockdown, the IA commented: "Rather than representing a breakdown of ETF pricing mechanisms, in actual fact ETFs were providing a key source of liquidity and price discovery."
