ETFs Gaining Ground On Mutual Fund Industry

by: Tom Lydon

Are ETFs the investment choice of the future? The ETF industry has taken in over $450 billion in assets and little by little they are gaining ground on the $8 trillion mutual fund industry. ETFs are an innovation that yields tax advantages, such as little or no capital gains, and cost reduction along with intraday liquidity and transparency.

Dave Lindorf of On Wall Street points out ETFs are typically purchased based on the past performance and future projected performance of their underlying indices. There currently are not any actively managed ETFs, but when they are rolled out they will not have the index track record to go on. These new products will be treated like conventional mutual funds--with investors basing their decisions to buy on the track records of the funds' managers.

During the late 1960's there were only a few hundred mutual funds, and the number didn't peak until the year 2000, when there were 11,000 mutual funds. Since then, underperforming mutual funds have been getting killed off at a rate of 300-500 per year. ETFs and their assets are expected to grow in part because of an investor shift away from mutual funds.

Morningstar Moves Into ETFs
Morningstar is well known for their extensive mutual fund ratings, analysis and data and now they are reaching further into the ETF segment of the industry. Their ETF coverage offers more premium analyst reports, an ETF exclusive subscription newsletter and their in-house indexes are being used more and more for the basis of new ETFs.

John Spence for SmartMoney reports a trio of their indices were licensed to Claymore Advisors, while Barclays offers a suite of ETFs tied to Morningstar's stock benchmarks and First Trust Advisors offers a dividend ETF tied to a Morningstar index. There are other style-box ETFs tracking indexes from S&P and Russell. These ETFs tend to have more assets - over $1 billion per ETF - while Morningstar's average about $200 million.

Morningstar offers a yearly guidebook on ETFs; the 2007 issue reports on 150 of the biggest and most popular funds (there are over 500 ETFs currently available). The ETFs receive a star rating if there is a 3-year history. Morningstar uses their stock analysis for ETFs, looking for ETFs that have cheap stocks, and buy and hold them for the long term.