If funds want to offer exchange-traded funds, they might be wise to follow SSB Citi Asset Management Group of New York and Whatifi.com of San Francisco and start by launching traditional index funds, according to some industry analysts.
Whatifi.com, an online money manager, received SEC approval July 14 to introduce four index funds and SSB Citi Asset Management has filed to introduce several index funds, spokespeople for both firms said. Both firms plan to offer an exchange-traded fund later this year, they said.
The index funds will prepare both companies to compete with existing exchange-traded funds, said Gavin Quill, director of research for Financial Research Corporation of Boston.
"There's tremendous overlap [between traditional index funds and exchange-traded funds] in terms of the skills, back office support and critical mass of assets you have to accumulate to launch an exchange-traded fund," he said.
But, at least one industry executive said that companies ought to consider going directly into exchange-trade funds rather than developing index funds first.
The tax and price advantages exchange-traded funds have over traditional index funds have made traditional index funds an outmoded form of index investing, said Gary L. Gastineau, managing director of structured investments for John Nuveen Co. of Chicago. Firms just getting into index investing are arriving late to the game and will find it hard to attract assets because of the competition from existing exchange-traded funds and exchange-traded share classes, he said.
"I think I would start with an exchange-traded fund because I think that's where index funds are going," Gastineau said. "If you're going to get into exchange-traded funds, why not launch one from the start?"
That is the strategy Nuveen is following. The firm, which has no index funds, plans to develop exchange-traded funds based on indexes it is now developing, said Gastineau.
Citi Asset Management filed in June with the SEC to launch index funds that will be sold online, said Edward Giltenan, a spokesperson for the firm. The funds are sector index funds and include the Citi Financial Services Index Portfolio, the Citi Health Sciences Index Portfolio and the Citi Technology Index Portfolio, according to the SEC filing.
The funds will be sold to retail clients and will include A and D share classes with operating expenses of 110 basis points and 90 basis points respectively, according to the filing.
Citi Asset Management currently has an exchange-traded fund in registration with the SEC and is planning to introduce it by the end of the year, Giltenan said.
Whatifi.com, on July 14, introduced four index funds that track the S&P 500 Index, Wilshire 4500 Index, Morgan Stanley Capital International Europe, Australia, Far East, Free (EAFE) Index and the Lehman Brothers Government/Corporate Bond Index. The funds include the Whatifi S&P 500 Index, the Whatifi Extended Market Index, the Whatifi International Index and the Whatifi Bond Index, said Monica Chandra, executive vice president of product marketing for Whatifi.com. The no-load funds will have expense charges of 55 basis points and will be sub-advised by Barclays Global Fund Advisors, a subsidiary of Barclays Global Investors of San Francisco, currently the exchange-traded fund giant.
Whatifi.com's relationship with Barclays will enable it to take advantage of Barclay's economies of scale and offer pricing advantages it could not offer if it launched the funds on its own, said Chandra. Barclay's expertise in exchange-traded funds will also help Whatifi.com's introduction of an exchange-traded fund, she said.
By launching index funds, both firms will compete in a category that is facing greater competition than most other categories of funds, according to FRC data. Flows into index funds have plummeted in the past year, dropping from a high of $23.2 billion in the first quarter of 1999 to $6.3 billion for the first quarter of this year, according to FRC.
Like Gastineau, some analysts question whether traditional index funds can compete with the tax advantages offered by exchange-traded funds. Traditional index funds are facing direct competition from exchange-traded funds, according to a study released by FRC in June.
"[Exchange-Traded Funds] are currently expected to have a much larger percentage impact on traditional index funds than upon traditional actively-managed funds," the study states. In five years, exchange-traded funds are expected to capture 27 percent of index funds' assets, according to the study.
The decision by the Vanguard Group of Malvern, Pa. to attach an exchange-traded share class to some of its index funds is evidence of the firm's tacit recognition of the impact the products will have on traditional index investing, said Kevin Rowland, an exchange-traded fund analyst with Wiesenberger of Rockville, Md. Wiesenberger, a supplier of mutual fund and exchange-traded fund performance data, is a division of Thomson Financial, the publishers of this newsletter.
"It will take a piece of their own flow," Rowland said. "There's no question. You'll see more outflow from index funds because exchange-traded funds will be widely accepted."
Even one of exchange-traded funds' most vocal critics, Jack Bogle, Vanguard's founder and former CEO, said at a recent Morningstar conference in Chicago that the products offer some advantages over traditional index funds.