It’s fashionable today to talk about how Exchange Traded Funds (ETFs) are laying the wood to the actively managed mutual fund industry. Cumulative flows into passive strategies and ETFs has been staggering, while the outflows from active funds have been similarly spectacular.
Some advisors and former brokers have become self-righteous about ETFs and indexing, but you didn’t hear a word about ETFs from this crowd for decades. ETFs have been around since 1993, but many in the industry were too busy hawking high expense ratio funds with monster front-end sales loads and back-end marketing scabs to be interested in ETFs.
Now investors are supposed to heed their advice? No thank you would be the polite response.
Maybe this crowd should be applauded for finally moving away from the high-fee closet index funds they have long promoted, but is charging your clients (well over 1% per year in some cases) to buy and hold three or four index based ETFs much better than churning high-fee front end sales load funds to rack up commissions?
At our shop we long ago forecast the downfall of much of the actively managed mutual fund industry.
Dick was in print as far back as November 2006 predicting the demise of many actively managed mutual funds (see excerpt below from the November 2006 is of Richard C. Young’s Intelligence Report). At the time, ETF market share was a tiny sliver of total managed assets. Today, ETF assets are approaching $3 trillion. Their impact on the market is even larger.
At our investment firm we find an individual securities approach superior to an ETF based approach as it allows for maximum customization, better tax-loss harvesting opportunities, and more diversification (read more on the latter point here). But on the few occasions where we do find the need for a fund solution, ETFs are the first place we look.
A Twin Shocker
I write often that the majority of mutual funds offer no compelling reason for investment. Here’s a double shocker for you. Of the top-ten largest equity mutual funds, seven come from one family. How could one management company capture so many places in the top-ten-size race? Must have pretty spectacular performance, right? That must be the reason. Well, performance has been fine, but the single compelling reason these funds sit at the top ten in size is that all seven have 5.75% front-end sales loads. Sales pressure gets big results. The majority of fund sales for load funds are made by salesmen to unsophisticated investors. No knowledgeable investor would invest in a load fund.
The second big surprise is that I now think ETFs have come closer to being in a position to overwhelm the mutual fund industry. For the ETF industry as a whole, it is a little early in the game because, as yet, not all the chairs at the table have been filled. The fixed-income side needs to broaden out a lot. I especially hope that Vanguard will substantially broaden its ETF menu. I would guess that within a year I will be able to give the green flag to the ETF industry as the lead horse in the long-term race between ETFs and the mutual fund industry. There will be a select group of mutual fund groups that will continue to prosper as the ETF industry hollows out the mutual fund industry…
Jeremy Jones, CFA
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