ETFs Expand and Take Market Share from Mutual Funds/Mutual Fund Managers Are Forced to Change

One of the hottest things going in the investment world is the ETF, or Exchange-Traded Fund. ETFs are baskets of different stocks for sale under one ticker symbol. They were originally designed to compete with index mutual funds (commonly called “index funds;” index mutual funds are invested so as to represent the performance of the Standard & Poor’s 500, the NASDAQ 100 or other popular stock indexes). However, ETFs quickly evolved so that they now compete with mutual funds that invest in specific industrial sectors, and, more recently, they compete with managed funds. There are, however, important differences between ETFs and mutual funds. The primary difference lies in the way they are priced. Mutual funds are traded and priced only once daily. ETFs act like stocks, fluctuating in price all day long as the underlying values of the stocks they hold fluctuate. ETFs tend to have low fee structures and offer quick, easy access to widely diversified baskets of stocks.

Since there are many smaller indexes that track specific business sectors such as retailing or energy (these indexes are maintained by investment banks and analysts), ETFs can easily be designed to be sector-oriented by following a specific industrial sector’s index.

These funds have experienced tremendous growth. The biggest players in ETFs by assets and market share include State Street Global Advisors (operator of the SPDR fund), iShares by BlackRock, Vanguard and Invesco.

ETFs have evolved and expanded to fill a wide variety of niches, appealing to investors who want to bet on indexes covering commodities such as gold, as well as oil, currencies such as the Euro, and tech stocks. ETFs are increasingly popular with individual investors and are expected to continue their impressive growth pattern. They provide investors with lower cost alternatives to mutual funds. A few offer the ability to bet against stocks or bonds. Since ETFs are bought and sold like stocks, investors trade them through stockbrokers.

As more and more individual investors become aware of ETFs, they have begun to displace mutual funds to a growing extent. This means that ETFs are showing up in the portfolios of numerous IRAs and 401(k)s.

ETFs typically have low management expense ratios, a significant advantage over many mutual funds. In addition, there are no up-front sales charges when buying ETFs as there are in some mutual funds. A final advantage to ETFs for some investors is that capital gains taxes will not be created for individual investors until they sell the ETF shares. In comparison, individuals owning mutual funds may find themselves owing taxes even though they have not yet sold their shares. Investment and brokerage companies such as Fidelity Investments, BlackRock, Vanguard Group, State Street Global Advisors and Charles Schwab are fiercely battling for market share of the U.S. ETF industry. Many charge no trading commissions on a large number of ETFs. Another gambit to lure trading customers is lower account value minimums. Fees for ETFs and other funds continued to drop.

Today, many ETFs are not tied exclusively to specific indexes. Instead, these are “actively managed” ETFs, run by stock pickers who hope to make investment choices that will beat the indexes. Typically, managers of these ETFs are free to trade in and out of stocks, based on a management firm’s own unique computer models and market forecasts. This puts the ETFs in direct competition with actively managed mutual funds. For example, Invesco PowerShares offers several actively managed ETF products. One is focused on shares in global biotech firms. Another is focused on trading within high market capitalization companies.

Another new trend in ETFs is smart beta funds which are specially designed indexes that track particular investment themes. For example, a fund might track companies that pay the highest dividends.

Major ETF Companies to Watch:

= BlackRock, Inc., owner of iShares ETFs, www.blackrock.com and www.ishares.com

= State Street Corporation, www.statestreet.com

= Vanguard Group, creator of the VIPER ETFs, www.vanguard.com

= Invesco, www.invesco.com/us/financial-products/etfs/performance?audienceType=Investor

= State Street Global Advisors’ SPDR, www.ssga.com/us/en/institutional/etfs

SPOTLIGHT: BlackRock, Inc.

BlackRock is the largest asset manager in the world, with $9.090 trillion in AUM at the end of March 2023. Its product mix is fairly diverse, with 52% of the firm's managed assets in equity strategies, 29% in fixed income, 8% in multi-asset class, 8% in money market funds and 3% in alternatives. Passive strategies account for around two thirds of long-term AUM, with the company's iShares ETF platform maintaining a leading market share domestically and on a global basis. Product distribution is weighted more toward institutional clients, which account for around 80% of AUM. BlackRock is also geographically diverse, with clients in more than 100 countries and more than one third of managed assets coming from investors domiciled outside the U.S. and Canada.

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