I listened to a well-known financial adviser glorify exchange-traded funds (ETFs) while speaking at the 2013 Inside ETF conference last week. There were 1,200 other people at the conference, many of them investment advisers.
This particular speaker’s take on ETFs was that they are a godsend for his clients. He switched to ETFs in 2006 because these index-tracking products have lower expense ratios than the traditional mutual funds that try unsuccessfully to beat the market. Not only was he saving his clients money, the index-tracking ETFs performed better as well, he said.
I started to become annoyed as this guy continued to wallow in his wisdom. There is no doubt that ETF fees are lower than the mutual funds he was picking in the past, and they had better returns then the “beat the market” funds he selected for his clients; my question is this, what took him so long to switch? This particular adviser said he didn’t switch because ETFs were “too new”. His answer is another prime example of how good marketing can rewrite history.
ETFs are not new. They’ve been trading on U.S. exchanges for 20 years. The first ETF was SPRD SPY, launched in 1993, to track the S&P 500 index. Nor are ETFs unique. They’re basically a mutual fund that tracks an index — just like index funds. The major difference is that you need a brokerage account to trade them because shares trade on a stock exchange during the day, rather than at the end of the day with a fund company.
The lower-cost argument is also bunk. Low-cost index funds have been around for decades. Vanguard launched the first successful S&P 500 index fund back in 1975 and has added dozens of index funds steadily since. Several other fund companies have also offered low-cost funds for decades.
If indexing isn’t new, then what’s the ETF buzz about?
Sometimes things happen on Wall Street for the benefit of Wall Street — and the boom in ETFs is one of those things. Traders love the product because the number of common stocks listed on U.S. exchanges has dropped by half since 1997 and ETF trading is filling the gap. Brokers adore them because they’re able to conjure-up spicy ETF strategies to keep their clients interested. Fee-only advisers like them because they can point to lower costs and better returns without having to lower their own fee.
Don’t get me wrong, I’m positive on ETFs overall. That’s why I wrote The ETF Book, now in its second edition. The average exchange traded fund (ETF) does have a lower expense ratio than the average traditional mutual fund, but not less than most low-cost index funds that have been available for decades. The structure of ETFs does lend itself to a more tax-efficient model, but that depends on each product also.
The “ETFs are better because they are low-fee and track indexes” argument is now commonplace among advisers. I think it’s great that more advisers are spreading the word about low fees and the poor returns of active management, but I don’t give much credit to the advisers who waited to switch only after their high-cost strategies failed. I am proud to say that I made the switch to all index funds and ETFs in 1999 when I launched Portfolio Solutions, one the nation’s first low-cost investment advisers.
