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Mutual Fund Firms Get Creative with ETFs


Mutual fund providers are getting creative in an effort to add exchange traded funds to their offerings. From “mimicking” to “master-feed” strategies, Vanguard may have the most successful patent yet.

“More than a decade ago, Vanguard pioneered the idea of offering ETFs as a separate share class of existing mutual funds to create economies of scale and keep costs low. The Malvern, Pa., firm later secured a patent on the structure and so far has kept a monopoly on it,” Ari Weinberg wrote WSJ.com.

Mutual fund companies are keen on the action and inflows into the ETF industry. In response, many of these managers are getting ready to add ETFs to their offerings. Some providers are creating offshoots of mutual funds already trading, such as PIMCO Total Return ETF (BOND) .

The latest re-design comes from State Street Global Advisors, creators of the first ETF to trade, SPDR S&P 500 (SPY) . The “master-feed” design involves connecting the ETF to an existing mutual fund, with the ETF holding only the same shares as the original. [What's Next in the ETF Fee War]

“Master-feeder is the beginning of a new innovation on improving the ETF structure,” Richard Keary of Global ETF Advisors, said in the WSJ story.

Master-feed is a structure that creates flexibility for the investor. Each feeder fund has its own costs and pays for portfolio management. The theory can be available for those investors who want a strategy but do not necessarily need an ETF. This is an efficient strategy that helps keep costs down. [ETFs, Index Fund Projected to Hit $10.4 Trillion by 2017]

Another strategy used is the mimicking method. An ETF is a take-off of an existing mutual fund, but stands alone as a separate investment tool. These are inexpensive to run, but high asset levels are needed to keep liquidity and operating costs down. The most successful of this strategy has been the Pimco spin-off, BOND. The ETF has attracted $4 billion in AUM after less than one year of trading. [Mutual Fund Companies Readying Active ETFs]

Vanguard patented its ETF design in 2001, and has since become the third largest ETF manager by assets. Investors can transfer mutual fund shares into ETF shares without tax penalties, and the share-class design takes away potential problems that occur when ETFs are launched as stand alone funds.

Tisha Guerrero contributed to this article.

Full disclosure: Tom Lydon’s clients own SPY and BOND.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.