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ETFs - The Wave of the Future
By Eric Daugherty
If I were starting an asset management firm today, my first product to market would not be a mutual fund - it would be a broad market Exchange-Traded Fund (ETF). And, if I were starting my investing portfolio today, I'd buy an ETF in lieu of a mutual fund.
At a Mutual Fund Education Alliance conference a few weeks back, a panel moderator asked me which of the "hot" product topics of the last few years were apt to persist. Among the products or structures mentioned were:
- Alternatives
- Guaranteed income products
- Emerging markets/international exposure
- ETFs
- Absolute return funds
While you could make a case that any of these currently hot products could persist, my immediate thought went to ETFs. According to Morningstar, the U.S. ETF Market is in excess of $1T in assets, and foreign ETF assets amount to more than another $1T. So, ETFs are already picking up steam.
For those less familiar with ETF vs. mutual fund differences, The Motley Fool does a creditable, and typically irreverent, job of explaining them here. And, this graphic from the ICI helps explain the details of ETF creation and distribution.
So, why do I think ETFs will continue to grab share long-term? Simple - they make sense for investors and advisors! Eventually, those groups catch onto things that make sense. ETFs can hold the same underlying investments as funds, and can provide expense (see article on ETF fee wars), tax management, and pricing benefits. These benefits always made them make sense in taxable accounts. The big limitation regarding ETFs was that buying & selling incurred brokerage costs; this made ETFs less suitable for 401(k) plans, dollar cost averaging, or smaller purchases. However, with brokerage fees coming down near/to zero, even this weakness is minimized. The only two things holding back ETF growth are: (1) investors' reluctance to switch from existing fund portfolios to ETFs, and (2) investors' not fully understanding ETFs' benefits.
Clearly, not all firms have launched into the ETF space. But, I think most should seriously consider them. In particular, Vanguard's quick market share gains help to prove that well-constructed, low-cost ETFs can ramp up very quickly. In ten years, I believe that ETFs will be the default option for most investors looking to put money to work outside (perhaps even inside) tax-deferred accounts. What mutual funds were to the second half of the 20th century, ETFs will be to the first half of this century.