Seeking Alpha
Profile| Send Message|
( followers)  

A study performed by New York-based research and consulting firm Novarica makes some bold predictions about the investment industry, painting a dismal picture for the future of traditional actively-managed mutual funds.

The study predicts that nearly half of mutual funds will disappear by 2015, being replaced by low-cost ETF alternatives. Among the highlights of the study:

  • The number of funds will decline from 8,022 in 2008 to 4,237 in 2015, with assets declining from $9.0 trillion to $6.75 trillion over that period.
  • The number of ETFs is projected to increase from 728 in 2008 to 2,618 in 2015, with assets in ETFs more than doubling from $500 billion to $1.15 trillion
  • The number of actively-managed ETFs will increase to 325 by 2015. Currently, there are only a handful of funds, including five PowerShares ETFs and Grail Avdisors’ initial offering (NYSEARCA:GVT).

Not surprisingly, the study points to the cost advantages of ETFs as one of the primary reasons for the predicted decline in popularity of mutual funds. Many passively-managed ETFs offer expense ratios that undercut active funds by as much as 100 basis points. Over long investment horizons, the impact of compounding the additional costs can have a material impact on bottom line portfolio performance. The study also predicts that

While I’m a huge believer in the benefits of ETFs relative to traditional actively-managed ETFs, I can’t help but be a bit skeptical of the predictions from the Novarica study. Reaching more than 2,600 ETFs by 2015 would require adding funds at a clip of about 25 per month, an outrageous pace.

According to monthly snapshot reports released by State Street, the industry added a net of seven new funds in April and lost 14 in May. While new fund offerings are a regular occurrence, the industry will need to increase its pace significantly to hit the 2,600 mark in six years.

Moreover, it seems to me that there is a tremendous amount of uncertainty surrounding the ETF industry. ETFs are not yet available for inclusion in the 401(k) portfolios of most investors, a fact that significantly limits long-term growth potential.

While the general thinking is that it is only a matter of time before this restriction is lifted, the timing of such a development is far from certain. Moreover, the actively-managed ETF space is still very young, with PowerShares having introduced the first funds in April 2008 and Grail launching the first ETF to provide total discretion to a team of managers earlier this year.

While these funds have shown tremendous promise already, they face tremendous obstacles as well, including the “disclosure dilemma” presented by reporting requirements for ETFs, as well as the same concerns over their ability to consistently generate a true alpha (and therefore justify a higher expense ratio) that have plagued actively-manged mutual funds.

Disclosure: No positions at time of writing.

Source: ETFs to Replace Half of Mutual Funds by 2015