NEW PRODUCTS

Within the next year, the mutual fund industry can expect to see a new share class attached to some equity funds that allows them to be traded throughout the day and includes features common to exchange-traded funds, according to executives in the mutual fund industry.

"I would expect that you'll see a gradual extension of the types of exchange-traded funds that are available," said Gary Gastineau, managing director of structured investments for John Nuveen Co. of Chicago. "There will be additional kinds of exchange-traded funds that will probably surprise people. Existing funds will add an exchange-traded share class, there will be actively managed exchange-traded funds and fixed income exchange-traded funds."

Gastineau was formerly senior vice president for product development at the American Stock Exchange, a position he recently left to work for John Nuveen Co.

Although exchange-traded funds and the variations that evolve could come to dominate the industry, Gastineau said that transformation would not happen any time soon. At the same time, he said, the evolution of exchange-traded funds will benefit regular funds.

"It is clear that by adding an exchange-traded fund share class, an existing fund will do a lot for existing shareholders and new shareholders in attracting more assets, increasing tax efficiency and reducing the impact of shareholders moving in and out of the fund," he said.

Eventually, Gastineau envisions all funds offering an exchange-traded share class. The first type of fund to offer an exchange-traded fund share class will most likely be an index fund because index funds most closely resemble exchange-traded funds, he said.

In the past year, assets in the various types of exchange-traded funds have grown from $15 billion to $42 billion, according to Avi Nachmany, co-founder and director of research for Strategic Insight of New York.

"Not all gains are new money, but this is a phenomenon that is for real and it's not just a fad concept," he said. "[Exchange-traded funds] have distinctive benefits."

While there is growing interest in exchange-traded funds, assets invested in them amount to a little less than one percent of total assets invested in regular mutual funds, he said.

Regulatory issues could play a significant role in the pace of asset growth in exchange-traded funds, said Gastineau. Currently, all exchange-traded funds need to be approved on an ad hoc basis by the SEC, a process that is too time consuming and expensive, he said.

It is in the SEC's best interest to issue a rule because it is spending a great deal of its time and resources working with fund companies seeking rule exemptions for new exchange-traded funds, said Kathleen H. Moriarty, a financial products and securities lawyer with Carter, Ledyard & Milburn of New York. Moriarty helped create the first SPDR for the American Stock Exchange and helped establish MidCap SPDR's and DIAMONDS trusts.

Another potential stumbling block in the growth of exchange-traded funds is a perceived reluctance by the Investment Company Institute to represent them, according to Gastineau. There are many members sitting on the ICI's board that do not want the ICI to represent exchange-traded funds, he said. That has put the ICI in an awkward position.

"Let's put it this way," he said. "If you are an established mutual fund company and at this point you don't see any compelling reason why you would want to do [exchange-traded funds], you may not want anyone else to do them either. There are some firms that want to defend the status quo."

"In terms of shareholder interest, safety, cost and transparency, these products are of God and motherhood. Anyone who objects to them looks greedy and silly. I think there is enough people aware of this that you haven't had public objections [to exchange-traded funds]. The ICI is supposed to be an industry statesman of sorts and if they come out in favor of these, there are a number of their major members that won't be happy."

Some of the ICI's board members are executives of firms that offer exchange-traded funds, so in a sense, the funds are already represented by the ICI, said Chris Wloszczyna, a spokesperson for the organization.

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