An increasing number of financial experts have begun slamming exchange-traded funds as too numerous, too specialized and not necessarily inexpensive, due to their trading costs.
But others believe that if the economy hits a rough patch, it will only boost ETFs' popularity as investors look to alternatives to mutual funds, TheStreet.com reports.
"People tend to change paths when they feel they've [been burned]," said David Abner, managing director of ETF trading at BNP Paribas. "If there is a serious market decline and people lose a lot of money, they may be somewhat shy about just putting money back into mutual funds when things turn around. They'll be looking for new ways to invest, and ETFs will benefit from that desire."
In addition, when markets decline and funds have to honor redemptions, that forces the hand of mutual fund portfolio managers to sell holdings that they may otherwise want to hold onto, noted Ronald DeLegge, publisher of ETFGuide.com. Investors may also gravitate to ETFs due to their lower fees and tax advantages, he added.
"The important factor here is that it is becoming more difficult to obtain double-digit or even decent returns," DeLegge said. "More investors are realizing they need to focus on things they can control to boost their returns."
Analyzing mutual fund flows in years of steep market declines, there certainly is a proven trend for investors to pull back on mutual fund investing. In 1994, they invested $84 billion in mutual funds, a 63% decline from the year before. In 2002, they invested $74 billion, 85% less than the previous year, and by 2003, mutual funds suffered outflows of $43 billion.
And there are signs the economy might be slowing. For one, if the Federal Reserve is finished raising interest rates, it could set off a trend for stocks to decline; Ned Davis Research found that in years when interest rate increases have ceased, stocks have declined an average of 4%. In addition, the GDP grew at 2.5% in the second quarter, slower than many economists expected; oil prices continue to soar; and real estate values are declining.