Ex­change-traded funds likely to see steady growth

Av­er­age in­vestors move more money into once-novel ve­hi­cles; here are the top trends for 2013.

Austin American-Statesman - - BUSINESS -

By Mark Jewell BOS­TON — Ex­change-traded funds re­main rel­a­tive up­starts com­pared with mu­tual funds. But they’re lead­ing the race for in­vestors’ as­sets, on Main Street as well as Wall Street.

Check out the key ETF trends of 2012, and it’s not a stretch to ask whether in­vestors might some­day com­mit as much cash to ETFs as they have to their more es­tab­lished cousins.

In­tro­duced in the early 1990s, ETFs ini­tially were trad­ing tools for pro­fes­sional in­vestors. Sim­i­lar to low-cost in­dex mu­tual funds, they track seg­ments of the mar­ket and try to match a bench­mark stock or bond in­dex rather than beat it. But ETF shares can be traded through­out the day like stocks. That makes it pos­si­ble to lock in a pre­ferred price with­out wait­ing for a clos­ing price. Mu­tual funds are priced only at the close of daily trad­ing.

Here’s a look at six ETF trends that are likely to con­tinue play­ing out in 2013:

In­creased ac­cep­tance

Although ETFs re­main bet­ter-known on Wall Street, their low costs and in­dex in­vest­ing ap­proach are draw­ing more av­er­age in­vestors. In­di­vid­u­als own about 60 per­cent of as­sets in ETFs. The

re­main­ing 40 per­cent are at­trib­uted to in­sti­tu­tional in­vestors like pen­sion funds and foun­da­tions, ac­cord­ing to a re­cent study by con­sult­ing firm Strate­gic In­sight.

Out­pac­ing mu­tu­als

ETF as­sets have dou­bled over the past three years, reach­ing $1.3 tril­lion. They con­tinue to grow at a faster pace than mu­tual fund as­sets. In 2012 — with more than $150 bil­lion in net de­posits through Novem­ber — ETFs are on track to match a 2008 record for the amount of new cash taken in, ac­cord­ing to Morn­ingstar. How­ever, for ev­ery dol­lar in an ETF, in­vestors have stashed $7 in mu­tual funds. So there’s still plenty of ground to make up. ETF as­sets are pro­jected to nearly dou­ble to al­most $3.5 tril­lion by 2016, ac­cord­ing to a study by Cerulli As­so­ci­ates. So with their faster growth rate, it’s not hard to fathom ETFs some­day ri­val­ing the cur­rent $8.9 tril­lion in mu­tual fund as­sets.

Com­peti­tors cut costs

A key ap­peal of ETFs has been the low­er­ing of their fees. Sev­eral in­dus­try lead­ers have re­cently cut ETF ex­pense ra­tios — the amount paid to cover op­er­at­ing costs, ex­pressed as a per­cent­age of as­sets. In­vestors need to con­sider much more than costs, but the re­cent re­duc­tions are a clear pos­i­tive. Charles Sch­wab, a rel­a­tively small player in ETFs, made a par­tic­u­larly bold move in Septem­ber. It re­duced ex­pense ra­tios at two stock ETFs to 0.04 per­cent, or $4 a year for ev­ery $10,000 in­vested. That’s the low­est in the in­dus­try, and also un­der­cuts the fees that in­di­vid­u­als pay at in­dex mu­tual funds.

The big­gest ETF provider, Black­Rock’s iShares unit, fol­lowed Sch­wab’s move by cut­ting fees at six of its largest ETFs in Oc­to­ber. Mean­while, Van­guard has re­duced fees at two-thirds of its ETFs over the past 14 months.

More trims are ex­pected as a re­sult of a move that will re­duce over­head costs. Van­guard is in the process of switch­ing the mar­ket in­dexes that 22 of its ETFs and mu­tual funds track to bench­marks pro­vided by com­pa­nies that will charge lower li­cens­ing fees.

Bond ETFs surg­ing

In­creas­ingly risk-averse mu­tual fund in­vestors have de­posited huge sums into bond mu­tual funds since the 2008 fi­nan­cial cri­sis. Bond ETFs also are en­joy­ing strong growth. This year, they’ve at­tracted $52 bil­lion in net de­posits through Novem­ber, reach­ing a to­tal of $245 bil­lion in as­sets, ac­cord­ing to Strate­gic In­sight.

Some $3.5 bil­lion has flowed into just one bond ETF. The Pimco To­tal Re­turn ETF (BOND) was launched in March, and it’s ex­pected to sur­pass $4 bil­lion in as­sets this month.

It owes much of its ini­tial growth to the star power of its man­ager, bond trader Bill Gross. The new prod­uct is an ETF ver­sion of his To­tal Re­turn mu­tual fund, the world’s largest, which has also seen a surge of cash come in this year. The ETF and mu­tual fund ver­sions pur­sue es­sen­tially the same in­vest­ment strate­gies, although reg­u­la­tory re­stric­tions pre­vent the ETF from in­vest­ing in fu­tures, op­tions or swaps.

Get­ting more ac­tive

Pimco’s new ETF is among a small but grow­ing num­ber of ac­tively man­aged ETFs that seek to out­per­form the mar­ket, rather than match an in­dex. Man­aged ETFs rep­re­sent a small frac­tion of over­all ETF as­sets, but they’re grow­ing fast. Among the big in­dus­try play­ers mak­ing moves into man­aged ETFs are State Street and Fi­delity In­vest­ments. State Street de­buted its first three man­aged ETFs in April, and Fi­delity this month filed a reg­u­la­tory ap­pli­ca­tion to launch its first such prod­ucts.

The strong sur­vive

De­spite in­dus­try­wide growth, many ETFs aren’t at­tract­ing enough cash to re­main fi­nan­cially vi­able. In fact, it’s been a record year for ETF clo­sures. Through Novem­ber, 101 ETFs had closed, ac­cord­ing to S&P Cap­i­tal IQ. Although more have been launched than closed, the num­ber of ETFs shut down this year is nearly four times the to­tal that closed in all of 2011.

Among the 1,200 ETFs on the mar­ket, there’s a big gap be­tween the big­gest and small­est in terms of as­sets. About four dozen ETFs ac­count for about two-thirds of all ETF as­sets.

The largest, the SPDR S&P 500 (SPY), has about $114 bil­lion. Most of those clos­ing had less than $10 mil­lion.

“Some of the smaller providers,” says S&P an­a­lyst Todd Rosen­bluth, “have got­ten re­li­gion, and re­al­ized they can’t keep prod­ucts out there if they’re too small and aren’t grow­ing.”

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