Are ETFs killing off Stock Mutual Funds?

The Motley Fool wrote a report “Are Stock Mutual Funds Dead?” where they report how ETFs are rapidly gaining over the traditional mutual fund.

“Although the U.S. stock market put up a solid performance in 2009 — propelled by a massive rally off its March low – investors aren’t investing in mutual funds. According to research from Goldman Sachs, there was no net inflow into U.S. equity mutual funds in 2009 — however, individuals did purchase $225 billion worth of stocks directly (including through ETFs) through the month of September.”   …….

“While any report of the death of stock mutual funds is an are exaggeration; there is no question that ETFs such as the industry heavyweight SPDR S&P 500 (NYSE: SPY), present a real competitive threat to traditional mutual funds. The best ETFs wrap index funds in a low-cost vehicle that is as convenient to invest in as a stock, which raises the level of competition in the overall industry and puts pressure on mutual fund managers to prove they offer value for money.”

While the article makes some valid points, I think it omitted some major advantages of open-end mutual funds over ETF’s:

1)  No-load Open-end funds can be bought without a bid-asked spread or brokerage commission.

2)  Because mutual funds only trade at the end of the day, there is no chance for high frequency trading programs to front-run limit orders in ETFs.

3)  Nearly all ETFs use a predictable, open strategy but they are subject to gaming or front running.

4)  Open-end mutual funds tend to trade with less volatility than ETFs, so they trend better and are more predictable.

The main advantage of ETFs over mutual funds is that they are not subject to exit redemption fees and they tend to have low expense ratios. I believe that for most investors that manage larger portfolios, the fact that they trade throughout the day is actually a disadvantage, because liquidity is fragmented and you are competing with high frequency trading programs to get a fair execution.




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