"We're definitely hearing more about mutual funds buying into ETFs," said Morgan, whose firm manages
ETFs are investment vehicles akin to indexed mutual funds, but that trade on exchanges, throughout the day, as if they were individual stocks. They also often have lower expense ratios, less cash drag and a better tax efficiency (because ETFs don't disperse capital gains-taxed dividends) than do mutual funds.
Morgan's belief in that ''superior structure'' is not that unusual among money managers. The ETF industry has grown dramatically over the last five years, from
Now, even its chief rival, the mutual fund industry-which holds about 10 times the assets of ETFs-is taking notice, and putting shares of ETFs into those holdings.
But they don't publicize it. And, according to at least one market participant, they avoid ETFs that invest in stocks.
Based on stock screening platforms and trading patterns he has observed, one
Any movement into ETFs by mutual funds has been difficult to track, said
Because of this difficulty, it has been hard to determine exactly how much of the mutual fund industry's
Indeed, according to Strategic Insight, just one of the Top 100 mutual funds (ranked by July assets) listed an ETF as a Top 10 Holding Type.
That one fund, the
"There's been a lot of talk lately about ETFs, their growth and how mutual funds are using these new vehicles. But ETFs are not new-they are simply wrappers for an investment approach," Dickson notes. "Mutual funds investing in ETFs is just the topic du jour."
That said, there are reasons mutual funds would seek out ETFs, he adds. The primary reason for mutual funds to buy into ETFs is to use the vehicles as a substitute for buying futures contracts while satisfying the requirement to have assets fully invested.
This strategy would also allow mutual fund managers to avoid the complexity and higher costs of futures contracts and of constructing and unwinding a futures bet.
Another advantage of ETFs for mutual funds, especially smaller funds, would be to allow the fund to gain exposure to sectors or international markets that would be difficult or costly to replicate with a straight equity buying strategy.
"Let's say there is a small fund that wants exposure to a certain international market," explains Vanguard's Dickson. Instead of the time, paperwork and back-office cost of setting up custodial agreements, the manager can simply buy into a U.S.-domiciled ETF that focuses on that particular country, he notes.
"It would be a much more cost-effective way to establish a diversified play," according to Dickson.
One note of caution in the mutual fund/ETF strategy is the "double-level fees" problem, several experts say. This occurs when an investor pays expense ratio fees both for the ETF and for the mutual fund that holds it. (Vanguard does not charge investors "double fees" when its mutual funds hold Vanguard-created ETFs, says Dickson.)
In addition to the fee problem, mutual funds that buy ETFs have another, more perceptual problem.
Many market watchers question whether mutual fund portfolio managers can be short-changing clients by simply passively holding ETFs that represent certain sectors rather than establishing an active position in that sector.
"I can't discount the 'lazy portfolio' scenario because it does happen," said Dickson. "And unfortunately for the investor they simply get a repackaged investment strategy at a higher cost."
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