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Must-know: Growing preference for ETFs over mutual funds

Stephanie Johnson

Why Wall Street’s biggest banks are entering the ETF space (Part 2 of 6)

(Continued from Part 1)

Preference for exchange-traded funds (or ETFs) over mutual funds

We’ve discussed the advantages of ETFs—transparency, low-cost, tax efficiency, and intra-day trading. Another advantage is the ability to easily diversify a portfolio into international stocks and bonds as well as commodities. You can read more about this in our article, “Why choose exchange-traded funds over other investments?

In this series, we’ll discuss another key aspect of ETFs that prompts investors to prefer investing in them.

Consider the following two investment options:

  1. An actively-managed mutual fund tracking a particular index.
  2. An ETF tracking the same index.

A wise investor with the above options would likely choose option B. Why? The reason is simple. Most actively managed funds don’t beat their indexes in terms of returns over even moderate periods of time. However, ETFs have lower expense ratios than mutual funds. They deliver better returns than mutual funds tagged to the same index.

The expense ratio is the annual fee that’s charged by the fund provider for managing the fund. The higher the expense ratio, the lower the total returns.

The average equity mutual fund charges between 1.3% and 1.5% in expense ratio. Meanwhile, the average equity ETF only charges 0.57%.

The ETF industry is poised for growth

The U.S. ETF market is huge. It also dominates overall ETF trading activity. Of the $15.7 trillion in global annual ETF turnover in 2013, the U.S. market share came close to 89%, or $14 trillion. It was up 7.7% since 2012. In 2013, ETFs grew faster and gathered more new net assets than mutual funds—within the equity and fixed-income spaces.

As a result, many traditional asset managers are implementing or fine-tuning strategies to enter the ETF industry. Recent examples are JPMorgan (JPM) and Wells Fargo (WFC). These banks have recently entered the ETF space with the JPMorgan Diversified Return Global Equity ETF (JPGE) and the SPDR Wells Fargo Preferred Stock ETF (PSK), respectively.

JPGE is a global equity ETF. It can be compared to State Street’s SPDR MSCI World Quality Mix ETF (QWLD).

Goldman Sachs (or GS) also laid the groundwork to launch actively managed ETFs in the U.S. The company filed with the U.S. Securities and Exchange Commission (or SEC) to introduce a series of active ETFs with its initial fund named the Goldman Sachs Equity Dividend Fund.

Continue to Part 3

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