ETFs vs. Mutual Funds: Five Trends Show ETFs Are Winning

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Includes: SPY, VTI
by: Andy Hagans

It's no secret that actively managed funds have fallen out of fashion. Many big names have touted the benefits of financial instruments that track an index, and ETFs such as SPY and VTI have enjoyed huge asset inflows as a result. In 2007, legendary investor Warren Buffett even announced, "A very low-cost index is going to beat a majority of the amateur-managed money or professionally-managed money." (Mr. Buffett actually recommends index mutual funds over ETFs because they discourage trading, but there's no question that the trend toward indexing is driving the growth of ETFs.) And while the asset management industry isn't a zero-sum game, it's clear that the growth of ETFs is occurring at the expense of the mutual fund industry.

The love affair with ETFs is not just a passing fad. It's true that the total assets in exchange traded funds are dwarfed by those in mutual funds. But ETFs were only introduced in 1993, and worldwide ETF assets now total nearly a trillion dollars. It's not inconceivable that within a few decades, total ETF assets will exceed total mutual fund assets.

Don't believe me? Too bad. The numbers are on my side. Here are five trends--backed by research--that document the growth of ETFs vs. mutual funds among every important metric.

  1. Investor assets are shifting from mutual funds into ETFs. See this Financial Research Corp. study, April 13, 2009, via WSJ:

    Consider this: for every $100 invested in 2001, $90 went into mutual funds, $8 went into index funds, and $2 went into ETFs. Fast-forward seven years: By the end of 2008, the share of mutual funds fell to around $81.5, while index funds attracted $9.5 and the remaining $9 went into ETFs.

  2. Investor interest is shifting from mutual funds to ETFs. See the Google Trends statistics, 2004-2008, via Rock the Boat Marketing:

    Typically, search volume is believed to be a proxy for relevance. In that context, the decline in searches for “mutual funds” at a time when mutual fund news references (see second, smaller graph) were actually higher than in previous years is just something that could cause one to invoke Jeff Foxworthy–you know, the comedian who tracks “things that make you go Hmm.” ...As a P.S. but not to make a point because of course ETFs have been gaining awareness since 2004, I also ran an “ETFs” search. And noted the difference in the scale between the volume on the two search terms.

    Check out the most recent comparison graph at Google Trends.

  3. Investor advisors and financial planners favor ETFs. Check out the recent survey by Charles Schwab, via Forbes.com:

    ETFs with their liquidity, transparency and cost efficiency are making their way to frontline investors. In fact, among a recent survey of Registered Investment Advisors by Charles Schwab, a full 79% say they now look to ETFs as their top investment vehicles for their clients.

  4. Investment in "alternatives" via ETFs is growing. Refer to the recent survey by Cerulli Associates via Financial-Planning.com:

    “We found that if you look at practice types—wealth managers, those in wirehouses and RIAs (registered investment advisory firms)—they use alternatives.” More specifically, they are relying on a certain type of ETF—those that are invested in currencies and commodities, she said.

  5. The bottom line: ETFs outperform mutual funds. OK, this isn't a study, simply a logical analysis in the article "Boot Weak Mutual-Fund Managers For Solid ETFs" at WSJ.com:

    "If you've got 100 managers all playing in the same sandbox, the index fund has to be in the top half because it has less expenses," [financial adviser Harold] Evensky [of Evensky & Katz in Coral Gables, Fla.] said. "And since the active managers in the top half don't stay there all the time, the index over time gradually moves up. [...] If I can be guaranteed funds that are always in the top half, that's pretty good," he added, "as opposed to trying to pick one that's going to be on top but may also end up on the bottom."

The mutual fund industry isn't going to die next year--or in the next decade. Active fund management will always have its place. But there's no question that the convenience, efficiency, and performance of ETFs will ensure their continued growth, probably at the expense of less-useful financial instruments. And that's a good thing for investors everywhere.

Disclosure: At the date of publishing, the author currently owns shares of an ETF mentioned in this article: VTI.