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Posted by on Sep 4, 2011 in ETF Education

Rumors of Mutual Funds Death Are Greatly Exaggerated

Rumors of Mutual Funds Death Are Greatly Exaggerated

I was re-reading an older article on Seeking Alpha titled, “It’s Official: Mutual Funds are Dead – 10 years of Horrifying Data”

It referenced a Business Week story:

The Business Week story points out that investors are pulling assets from domestic mutual funds.  The data is there, you can’t argue that, however they then look at the flows into ETFs to say that the money is moving there, and it’s a demonstration that investors believe less in active management.  I think that could be a bit of a stretch.  When you look at ETFs, remember they heavily populate the most actively traded securities on the exchanges on any given day.  There is far more dollar value of ETFs traded than actual assets in ETFs.  This is because the ETF is a more universal structure for a pooled investment (mutual fund).  It is easily accessible by do-it-yourself-investors, financial advisors, hedge fund, and institutions, including endowments and foundations.  That is the great thing about the ETF structure; it democratizes accessibility and pushes the cost associated with access to the ones who use it the most.  So for hedge funds that actively trade ETFs, they pay the commissions and spreads, for the cost of their activity.  Those costs are not spread to the other buy and hold investors.  In fact, it’s their activity that creates tight spreads which is a benefit for the buy and hold investors in ETFs when they eventually buy or sell their ETF shares.  It is clear based on trading volume, that a significant portion of ETF assets are not from your typical mutual fund investor.  In fact when you look at where the bulk of the index-based ETF assets are, $388b are in the top 10 ETFs (as of end of May), representing the biggest indexes, which before ETFs were around, institutions and hedge funds, would use futures, swaps, or in some cases their own stock baskets to gain and trade this exposure.  It fair to say if just over a 1/3 of the index-ETF assets are in these top 10 (total ETF assets as of the end of May $891B) indexes, some reasonable portion of these assets are taken from assets that might go somewhere besides mutual funds.

Regarding the seeking alpha article which draws the conclusion that investors are giving up on active, for the reasons they state, we disagree.  It uses as its argument, that in 2010 domestic funds saw net outflows of $51B and ETFs, and as a comparison, the article says ETFs grew from $31B to $870B.  But that is in all asset classes.  Not exactly an apples to apples comparison.  Looking at ICI data for 2001-2010, you find the following:

Asset Growth for Long Term (not money market) Funds:     $1.711 Trillion

Asset Growth for all index ETFs                                            $769 Billion

Just a trillion off, not too bad.  Keep in mind, the mutual fund numbers likely include index mutual funds as well.  And there is no doubt that indexing is growing.  Also according to the ICI, index equity mutual funds have increased their market share from 9.8% in 2001 to 14.5% in 2010.

But as everyone knows, we are not here to extol the virtues of mutual funds, in fact, just the opposite, we believe that active ETFs are the way investors will access their fee-based/no-load funds.    And, ETFs are definitely gaining on them.

Here are the Mutual Fund numbers:

2001    129,188

2002    120,583

2003    215,843

2004    209,851

2005    192,086

2006    227,104

2007    223,898

2008    -225,027

2009    389,990

2010    227,825

And the ETF numbers:

2001    31,012

2002    45,302

2003    15,810

2004    55,021

2005    53,871

2006    65,520

2007    141,555

2008    166,372

2009    87,336

2010    108,137

The growth rate for ETFs is significantly better.  What we would want investors to know is that we do believe ETFs are a superior structure, but not without it’s bugs.  But they have a long way to go to make a dent in the traditional mutual fund industry.  Active ETF are growing too, but stop declaring each year, “the year of active ETFs”.  There are still a significant number of regulatory hurdles to get an active ETF to market.  In addition, active ETFs will need to prove themselves.  Several are starting too, and as investors see the benefit of an alpha basket for their portfolio, active ETFs will see the same time of growth as other product structures.