Investment advisor Matthew Tuttle spends a lot of time moving the money of newly-acquired clients out of mutual funds and into exchanged-traded instruments.
His clients are frustrated over high management fees, which they feel aren't deserved because many of their mutual funds lost money last year.
"By and large, these people are lucky if they made no money over the past few years. Most of the people we see coming through our door haven't been lucky though," says Tuttle, chief executive of Tuttle Wealth Management. "So, we use ETFs maybe 95% of the time now. Clients appreciate it."
Financial advisors such as Tuttle represent the front lines of raging conflict between mutual funds and exchange traded products, in particular over management fees and related costs.
At this point, ETFs are gaining ground. Their share of the market-$1 trillion, roughly-is still a fraction of traditional mutual funds, which have $23 trillion under management worldwide and $12 trillion in the United States. But the flexibility and lower fees of exchange-traded funds are drastically, and perhaps irreversibly, altering investor psychology.
"What ETFs have done is actually highlight the cost of ownership of different types of products. Part of that is looking at the performance of active funds," said Deborah Fuhr, a partner and co-founder of research firm ETF Global Insight. "The challenge is that many funds don't meet their benchmark."
It's hard to argue against the numbers.
First, consider the fees themselves. According to data from Lipper's Advisors Guide to Fund Expenses, the average fee for actively traded funds in 2010 was 91.8 basis points, while the average for an ETF was 55.1 bps (2011 figures are not yet available). The SPDR S&P 500 Index ETF charges only 11 bps.
Investors pay an annual fee for both ETFs and mutual funds, so the difference adds up. Assuming an investment of $10,000, this translates into $91.80 per year for mutual funds, $55.10 for the average ETF, or $11 for the SPDR S&P 500.
Then factor in the recent performance of many active mutual funds, as tracked by the year-end 2011 S&P Indices Versus Active Funds (SPIVA) scorecard. Over the past five years, 62.86% of global equity funds, 72.41% of global fixed income funds and 61.88% of domestic equity funds were trounced by their respective indices.
Ergo: the BlackRock Investment Institute reported recently that assets held in exchange-traded products jumped 12.8% year-to-date to reach $1.72 trillion at the end of February. Combined, the inflows for January and February of $52.4 billion are 111% higher than the first two months of 2011 when the industry captured $24.8 billion.
"Even mutual funds that appear really cheap in their category are still extremely expensive when compared to an ETF," Todd Rosenbluth, senior director for Research & Analytics at S&P Capital IQ told Money Management Executive. "When a mutual fund fails to beat the benchmark, people start to wonder what they paid the extra 50 bps for."
ETFs won't topple mutual funds any time soon. The Investment Company Institute says combined U.S. mutual funds rose $440.8 billion, or 3.8%, in January. That, by itself, is more than a third of total assets invested in ETFs, which reached $1.18 trillion at the end of February, according to the ETF Snapshot published by State Street Global Advisors.
However, statistics from the ICI and research firm iMoneyNet show that mutual funds may be losing battles. The data, presented at the 2012 ICI Mutual Funds and Investment Management Conference in Phoenix, shows that the mutual fund industry collected $12.5 billion in fees in 2008, and waived only $1.8 billion. However, by 2011, the industry collected only $4.7 billion and waived $5.2 billion. Fee waivers often work like price discounts.
Fees frequently come up in advisor discussions. Mutual fund owners can get hit with charges for buying into and redeeming a fund as well as for the transaction fees related to rebalancing underlying securities. Depending on how the mutual fund is constructed, investors can also get hit by 12b-1 marketing and distribution fees, custodial costs as well as accounting fees.
For Melville-N.Y.-based financial planner Bill Hammer, discussion centers on what clients will pay for. Hammer's clients, the majority of whom have about $2 million in personal wealth, have no qualms paying financial consultants for advice. However, few now will shell out big bucks for portfolio managers.
"The idea of paying 2% of assets and 20% profit to a hedge fund manager because the manager is hot doesn't work any more," Hammer says. "A lot of people got burned by hedge funds."
Meanwhile, many clients of IRAMarket.com chief executive Bill McNulty try to control costs as much as possible because they can't control performance-and they know costs add up. For example, if a retail investor parks $25,000 in a pension plan which achieves, on average, 6% annualized growth, every 50 bps of management fees translate into nearly $12,000 in reduced savings after 25 years.
"The mega-trend is towards lower fees," McNulty says. "Of course, everyone wants performance and cares about that first. But lower fees are the only sure thing you can do to help boost performance-all things being equal."
Andrew Aran, a partner at Regency Wealth Management, says partners at his firm pull together assets of several clients to create pools of 25ormore stocks, to cut costs.
Indeed, the advantages ETFs offer for simplifying transactions often cut costs as dramatically as the low fees. For example, they can be traded intraday while a mutual fund sale closes at day's end. There is usually daily transparency with ETFs, compared to quarterly mutual fund reports. ETFs also offer a variety of tax advantages. Perhaps most importantly, ETFs don't hit investors with the burden of breakpoint reporting, according to Bob Williams, managing director of Delta Trust Investments, Inc. They are also among the cheapest ways to cover a specialized sector, he says.
"Mutual funds can't beat the intraday liquidity, the portfolio transparency or the tax advantages. You get a lot of benefits for the fees you pay in an ETF, in my opinion," Williams says. "You get the best bang for your buck."
Mutual funds aren't completely defenseless in this battle. They require much less expertise from the investor. Since they are traded like stocks, ETFs also have transaction fees. Moreover, if a particular ETF is failing and lacks liquidity, unprepared investors can get hit by nasty bid-ask spreads.
Nonetheless, "it will be more and more important for traditional funds to explain how and why they are different, why they are more expensive-and why there is value in that," said Lipper fiduciary research analyst Sasha Franger.