Advisors Take Advantage of ETFs' Popularity
Mutual funds that invest exclusively in exchange-traded funds (ETFs) are growing in numbers as the popularity of ETFs themselves has grown dramatically.
Many fund advisors are realizing that they can create cost-effective ETF-only mutual funds and make a grab for a piece of the assets flowing into these preassembled and transparent baskets that trade like a single security.
As of March 31, the universe of 212 ETFs had grown to over $321 billion in assets, according to the Investment Company Institute of Washington. Over the past 12 months, ETFs have taken in a remarkable $92.5 billion, with the subset of 206 domestic and international equity ETFs leading the charge.
That growth has not gone unnoticed. Within the past year, several new funds-of-ETFs have been registered with the Securities and Exchange Commission, and many have successfully launched.
AIM Investments of Houston is reported to be considering launching a future mutual fund that would assemble selected ETFs crafted by PowerShares Capital Management, the ETF firm AIM is set to acquire by the end of the year. A traditional mutual fund that could leverage PowerShares' strong ETFs would make sense, said one source who spoke on condition of anonymity.
But before any fund advisor can launch a fund-of-ETFs, it must apply for, and receive, an exemption from the SEC allowing for the relaxation of limitation rules regarding specific limits on investments in other investment companies.
Rydex Investments of Rockville, Md., makes two funds-of-ETFs available to variable annuity holders, but does not offer non-annuity versions. Although Rydex sponsors nine of its own ETFs, if the firm were to ever launch such a fund-of-ETFs, it would include non-proprietary ETFs alongside its own, said Tim Meyer, Rydex's exchange-traded fund business manager. The challenge with a fund-of-ETFs can be in attracting investors, because anyone comfortable with investing in single ETFs " doesn't want a single solution," he noted.
One of the most recent, and perhaps unusual, fund-of-ETFs recently registered for sale is one from the American College of Surgeons in Chicago. The group was founded in 1913 and is a scientific and educational organization dedicated to the practice of surgery. With 70,000 members worldwide, it is the largest organization of surgeons.
In May, the group registered the Surgeons Diversified Investment Fund, which expects to invest up to 30% of its assets in fixed-income ETFs and 70% of assets in equity ETFs, with roughly 50% of that in domestic equity ETFs and 20% in international equity ETFs. Surgeons Asset Management will be the manager of the fund-of-ETFs, but an as of yet unnamed sub-adviser will allocate assets among up to 17 existing ETFs, including various iShares from Barclays Global Investors of Boston and Vipers from Vanguard of Valley Forge, Pa. Once the fund-of-ETFs reaches assets of $100 million, additional sub-advisers will be added to each to manage a portion of the fund.
Members of the American College expressed a need for investment management assistance, said Gay Vincent, comptroller of the organization. The plan was to go with a more passive management approach rather than a mutual fund that was actively managed in order to "keep the costs as low as possible," she said. But early attempts to secure an external investment manager to create a private-label fund for the American College didn't pan out, she added. Consequently, the American College's own registered investment advisor will manage the fund.
The goal is to announce the debut of the new fund to members later this year when they attend the group's annual membership conference in October, Vincent added.
Keeping costs low also means minimizing profits. The new fund will be offered to members, their families and their employees, all without a sales charge of any kind, although the fund's management fee is a healthy 1%.
Nonetheless, the American College doesn't intend to rake in huge profits on the fund. According to the fund's preliminary prospectus, because the fund is being offered as a benefit to the organization's members, "the manager does not expect to generate a profit."
The fund-of-ETF concept is easy for an investment advisor to manage, said Don Cassidy, senior research analyst at Lipper of New York. There is no single-stock selection, and managers can take advantage of all of the features of ETFs. A fund-of-ETFs could be attractive to investors as a single point solution, in much the same way a lifecycle fund aims to be a single do-it-all fund, he said.
What makes this type of new-fangled wrinkle on funds-of-funds so palatable to advisors is that "ETFs are so efficient," said Peter J. Nagle, a sole proprietor advisor based in Little Silver, N.J. He introduced the Nagle Total Market Plus Fund, which invests in various ETFs using a proprietary allocation model, in May. Nagle's fund has a bit of a twist in that it employees a covered call strategy intended to juice up returns.
"If a genius manager picks the right ETFs, this could be great," said Robert W. Colby, senior market analyst at TradingEducation.com, a Chapel Hill, N.C., service that provides fundamental and technical analysis to individual traders. Of course, that would entail always picking, say, the top 10 ETFs with the strongest returns, he said. But if the fund-of-ETFs assembles a truly passive, broad portfolio of ETFs, the risk is that the returns will become watered down, he commented.
The most innovative funds-of-ETFs to recently launch are from J&W Seligman of New York. This past October, it married the fund-of-ETFs concept with traditional target retirement funds and launched three target date funds-of-ETFs: the Seligman TargETFund 2015, the Seligman TargETFund 2025 and the Seligman TargETFund Core, the latter of which is designed for those who are near or already in retirement. All three funds are based on Seligman's two proprietarily developed asset allocation strategies. Each fund sports a 50 basis point management fee, but certain fee waivers are in effect to reduce overall expenses.
Why use ETFs? Besides their cost-effectiveness and ease of use, said Charles W. Kadlec, co-portfolio manager of Seligman's Target ETF funds. "There's a growing demand for ETFs, and this is one way to make them available for 401(k)s," Kadlec said. With the growth of best-in-breed investment programs, there's been a reluctance by investors to invest elsewhere, he said. "Using ETFs allows us to provide a manager-neutral solution."
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