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With more than $1 trillion in assets, exchange-traded funds have become a gold mine for the companies that operate them. But with managers of traditional mutual funds fearing that they're losing out on the hot ETF trend, you'll soon see new ETFs that look a whole lot more like their actively-managed mutual fund counterparts. With higher fees and tenuous benefits, you should think twice before you jump on the active ETF bandwagon.
Wall Street wants more money
ETFs have revolutionized investing, especially for beginning investors. By focusing on simple index-based strategies, it's far easier for investors who are just starting out to put together an asset allocation strategy that gives them exposure to all the different types of assets they'd want in a portfolio. And thanks to the low expenses on a wide variety of ETFs, you don't have to pay an arm and a leg to set up an ETF portfolio.
What's good for investors, though, spells trouble for companies that make their money managing assets. For Eaton Vance (NYSE: EV ) , AllianceBernstein (NYSE: AB ) , and Janus Capital (NYSE: JNS ) , the ETF boom means a potential drain on their traditional mutual-fund assets. That's why they and several of their peers either have gotten or are seeking permission from the SEC to launch actively managed ETFs.
Warning: trouble ahead?
With hundreds of millions of dollars in net income at stake, it's no surprise that mutual fund companies are taking steps to defend their turf. But several factors weigh against active ETFs.
First, age-old debates about whether active investing can beat passive indexes in the long run apply just as much to ETFs as to regular mutual funds. Given that active ETFs will most likely charge significantly more than index ETFs in annual expenses and other fees, the managers of active ETFs would start out playing catch-up to their cheaper index counterparts.
Another argument is more specific to the ETF format. Regular mutual funds typically report their holdings either monthly or quarterly, giving fund managers some time to benefit from their proprietary research before disclosing their picks to investors. But with ETFs disclosing their holdings on a daily basis, shareholders would essentially be paying up for information they could get for free simply by waiting for active ETFs to announce their holdings at the end of the day. Sure, there'd be a few hours' lag, but compared to a period of months, that's not much time to gain a true advantage.
ETFs at the right price
With all those concerns, the reasons to jump quickly into active ETFs aren't very compelling. Instead, consider a strategy with the following index ETFs:
- For stocks, a broad-market fund like SPDR S&P 500 or Vanguard Total Stock gives you index-matching results year in and year out. Or for big-cap investment with a focus on dividends, Vanguard Dividend Appreciation (NYSE: VIG ) is a good choice.
- Don't neglect international stocks. iShares MSCI EAFE and Vanguard MSCI Emerging Markets (NYSE: VWO ) are good choices to flesh out the global scope of your portfolio.
- On the fixed-income side, big funds like Vanguard Total Bond cover the full range of bonds. Those who want to drill down a bit more might want to add dollops of specialized funds, such as SPDR Barclays High Yield Bond (NYSE: JNK ) , for the greater yields available from the junk-bond market.
- A small sprinkling of other asset classes, whether it comes from commodity plays like SPDR Gold Trust or from real-estate ETF Vanguard REIT Index (NYSE: VNQ ) , can give you a completely well-rounded portfolio.
With these low-cost ETFs or others like them, it's easier than ever to set up the ideal investment strategy to meet your individual needs. And if they give you the strategy you want, why do you really need active ETFs in the first place?
If you want some more good ideas on ETFs that can help you get the results you want, don't miss out on the Motley Fool's special free report on ETFs. You'll find three great funds that won't hurt your wallet but will boost your returns.