Exchange-traded funds are booming. Yet while the growth rate for ETFs has trounced that of open-end funds, the traditional mutual fund is far from dead. Assets under management surged globally to $1.5 trillion in early 2012 from $25 billion in 1997, according to figures compiled by ETF Global Insight, a London-based consulting firm.
While much of the growth in ETFs has come from retail users, surveys show that most advisors are employing at least some ETFs. Late last year, a Charles Schwab study found that more than eight out of 10 independent registered advisors incorporated ETFs.
"It's very rare that I don't include ETFs" in client portfolios, says Ken Robinson, owner of Practical Financial Planning in Cleveland. "For passive investments, I almost always find myself using ETFs now. Even when you factor in the trading costs, they're typically less expensive than other options.''
While the growth rate for ETFs has pummeled that of open-end funds, traditional mutual fund assets are still strong. Morningstar estimated that, at January's end, the value of U.S. ETF assets were $1.15 trillion, compared with $8.3 trillion for open-end funds, excluding money market and fund-of-funds portfolios.
Most advisors use both ETFs and mutual funds, says Anthony Rochte, senior managing director of Boston-based SSgA Funds Management. SSgA is both the second-largest ETF provider and a major player in the traditional mutual fund business. The company's SPDR S&P 500 ETF (SPY), the first U.S. exchange-traded fund, is running neck and neck with the Vanguard 500 Index fund in the race for most assets under management in a retail portfolio tracking the benchmark S&P 500.
Some industry watchers, though, think that pitting ETFs against traditional open-end mutual funds is a meaningless faceoff. "A lot of times these comparisons of ETFs versus funds mask other things," says Joel Dickson, principal and senior investment strategist at Vanguard, one of the two biggest mutual fund companies and the third-largest ETF sponsor.
Dickson says that the choice between ETFs and open-end mutual funds has been driven not by the structure of the investment, but by "the distribution platform that is available to the advisor." Before ETFs, commission-based advisors had no access to the indexing giant's portfolios. Vanguard has never paid for distribution on its mutual funds, Dickson says.
But the company's ETFs are available on brokerage platforms, making it easy for both commission-based and fee-based RIAs to use them in constructing portfolios. "That's in many ways why the ETF has blossomed in the financial advisor community," he says.
As with Vanguard's products, most ETFs in today's marketplace are index funds. As a result, some planners shun them as core holdings because of current market conditions. "Right now, we're more on the managed equity side than on the indexed equity side," says Jim Holtzman, an advisor and shareholder with Legend Financial Advisors in Pittsburgh. "We don't want to get into indexes right now," he adds, citing the whipsawing effects of market volatility.
Holtzman notes that since the late 1990s, stocks have moved sideways. What's more, he believes that investors have become complacent. "We think there are more drops to come," he says.
Holtzman does use ETFs as tactical tools to provide exposure to areas that can't be accessed efficiently through traditional mutual funds. Mostly he uses gold, coal and agribusiness ETFs in more aggressive portfolio strategies.
In contrast, Robinson, of Practical Financial, says he avoids anything that might be considered a novel ETF. "I'm not an early adopter," he says. "The ETFs that I use tend to be with companies that have been doing indexing a long time and they're very boring and garden variety."
Although Robinson sometimes uses actively managed funds, he usually opts for indexed portfolios. It's a preference that his clients share. "If they have a strong opinion that it's all about active management, they probably wouldn't be my clients," he says.
Does the choice come down to passive strategies versus active ones? SSgA's Rochte thinks not: "The conversation is less and less about indexing versus active," he says.
"I think there's been a bit of a mischaracterization of terms," adds Vanguard's Dickson. "ETF does not have a one-to-one correspondence with index," he says, noting that his firm's sales of open-end index funds have been strong. Much of the company's growth in open-end index fund sales has been in the defined contribution market where target-date portfolios have become increasingly popular.