Unlocking Real Value Blog

AK Quoted: Poll: Competition From ETFs Is Top Industry Challenge

Published on February 24, 2011 – Ignites – An Information Service of Money-Media, a Financial Times Company – written by Gregory Shulas

Competition from exchange-traded funds ranks as the biggest challenge facing the mutual fund industry. That’s according to a plurality of Ignites poll respondents.

Roughly 45%, or 155 voters, said ETFs, along with collective investment trusts, are the biggest threat to mutual funds. That made it the top option in a survey asking readers to identify the industry’s top challenge.

The high ranking comes more than two months after ETFs hit the milestone of $1 trillion in assets under management, and as more active mutual fund firms seek to launch their own ETF products. Some industry observers contend that the growth of ETF products is coming at the expense of mutual funds.

The Dodd-Frank Act received 17%, or 58 votes, coming in a distant second. The lackluster showing may reflect the lack of clarity regarding the law’s ultimate impact on the industry, due to Congress’s current reluctance to fully fund the legislation.

The industry’s concerns about poor equity product inflows appear to be diminishing as only 13%, or 45 voters, said weakness in that asset class is a top concern. Meanwhile, 9%, or 31 voters, said 12b-1 reform is a top challenge.

Rounding out the results were “mitigating the risks, losses imposed by low-yielding money market funds,” with 8%; “tougher scrutiny by SEC, Finra,” which received 6%; and delays in getting derivative-oriented products approved by the SEC, which collected 3% of the vote.

The top ranking for ETFs as a competitive threat to the industry is a development that fund professionals should take note of, says Paul Justice, director of ETF research at Morningstar. The option’s popularity partly stems from the fact that passive product advocates are having an easier time selling their story to post-crisis investors than their active management counterparts, he says.

“I think people responded this way because mutual funds have a harder time defining their value proposition to investors. ETF providers have effectively explained the tax efficiencies and the low costs of their products, saying, ‘Look at my expense ratio.’ What the mutual fund industry has failed to do is say that we charge more but we provide better services,” Justice adds.

Andy Klausner, principal at AK Advisory Partners, says the readers’ concerns about ETFs mirror what he sees firsthand in the industry. “I am not surprised by the poll results. ETFs have become increasingly popular and have been a focus of the press for more than a year. While there has been some negative publicity over some of the more esoteric and risky leveraged ETFs, mainstream ETFs have gotten positive feedback overall,” Klausner says. He adds that the mutual fund industry has a right to be concerned.

“Investors have never really understood the pricing of mutual funds — the many so-called hidden fees — and I don’t think the industry has ever done a good job of explaining them,” Klausner says. “Many sophisticated investors today are still confused about mutual fund fees. On the other hand, ETF fees are pretty straightforward and low.”

Brian McCabe, partner at Ropes & Gray, is surprised that Dodd-Frank collected only 17% of the vote. “I would have expected that, given the importance and sheer volume of regulatory changes occasioned by Dodd-Frank, respondents would have considered it, if not the top industry challenge, certainly a closer second than what the poll revealed,” McCabe says. “I’m not surprised to see that competition from ETFs and collective investment funds finished high on the list, but the margin by which it bested Dodd-Frank is surprising,” he adds.

Yet the industry still seems to believe that mutual funds have the strongest prospects, despite ETFs’ market gains. In a Dec. 14 Ignites reader poll, 51% said ETF assets won’t surpass mutual fund assets in the near term. That made it the top sentiment expressed in the poll. Of that group, 26% said it would take another 20 years for ETFs to surpass mutual funds, while 25% indicated it will never happen.

As of 3 p.m. Tuesday, nearly 350 Ignites subscribers participated in the survey, which is an unscientific sampling of the publication’s subscribers. Readers voted only once on a voluntary basis. Ignites’s audience consists of financial advisors, money managers and service providers.

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