Tuesday, November 17, 2009

ETF Pollution Rises to a New Level

Among investors who have heard of exchange-traded funds (ETFs), their level of understanding often doesn’t go much beyond “ETF good and mutual fund bad”. This shouldn’t be too surprising. We can’t all be experts at everything. But the line between ETFs and mutual funds is becoming blurred and investors will need more knowledge to make good choices.

As Jonathan Chevreau reports, many investors demand ETFs from their advisors, and now Invesco Trimark is offering “hybrids” of ETFs and mutual funds to meet the demand (the web page with this article has disappeared since the time of writing). We should be suspicious about calling these products ETFs when they can be sold by advisors who are only licensed to sell mutual funds.

As Rudy Luukko of Morningstar explains, most of these new products are actually regular mutual funds that invest in a single ETF. These new funds pay a trailer fee of 1% per year to advisors who sell the funds to their clients. Hapless clients, who can now be told they are buying ETFs, will pay a management fee that includes the 1% trailer plus the management fee of the underlying ETF for a total between 1.65% and 1.9% each year.

This solves financial advisors’ problems nicely. If clients want ETFs – no problem – they can have ETFs. Never mind that the underlying reason why clients want ETFs is to pay lower fees. These new products are hybrids only in the marketing realm. In reality, they walk and talk like mutual funds, but advisors can call them ETFs.

Until investors seek lower fees and demand to be told what their investments cost, they can expect more marketing efforts like this to keep them paying high fees.

7 comments:

  1. I believe the term Hybrid is now synonymous with "... not what you think it is ..." or worse "... you don't know what this REALLY is ...".

    Hybrid implies you get the best of both worlds, whereas it usually means you get the worst of both.

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  2. I wrote this in another forum but part of the issue is regulatory. Most advisors cannot sell ETFs because they are only licensed to sell mutual funds. How about one over-arching regulatory body that levels the playing field and mandates disclosure of all alternatives?

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  3. These products being costlier than they should be is one issue. Another is their narrow, niche focus more suitable for speculation; not investing.

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  4. Thicken: Your suggestion sounds reasonable, but I'm no expert when it comes to regulatory bodies. It would be nice to see the standards for getting licensed to sell mutual funds be a little more stringent. I like the idea of mandating disclosure of alternatives. I would like it even better if advisors had to disclose the actual dollar amount they are making off a client.

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  5. CC: I agree that most investors are better served with broad indexes than niche products.

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  6. Don't these new ETF funds have some special tax savings?

    The niche stuff is good, you can't get it anywhere else. I recently read an article in Canadian Business magazine about how water is the new oil. So I'm thinking about the water fund.

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  7. BeachTO: Invesco Trimark claim their mutual funds will do a better job of deferring capital gains distributions than ETFs. However, given the way they answered other criticisms, I'd wait for independent confirmation of that claim. Broad market index ETFs have only modest distributions. Narrower ETFs can sometimes have larger distributions. However, the higher MER on the new funds is a high price to pay for the possibility of some modest tax benefits.

    Water may be the new oil, but that fact is already built into equity prices. For this investment to beat other equities, water has to be the new oil by more than people already think. Good luck.

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