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ETFs vs. Mutual Funds

Sure, it's easier to grow quickly from a smaller base.

And, sure, it's hard to compare dollars in 1940 to dollars in 2010.

Be that as it may, it took mutual funds 50 years to go from $450 million in assets under management (1940) to $1 billion (1990).

Exchange-traded funds took only 17 years to make the same leap. The new form of mutual fund, which could be bought and sold within a trading day, went from $464 million under management in 1993 to $1.0 billion at the end of 2010.

They are still way behind mutual funds in popularity and inflows. All told, $11.8 billion was held in mutual funds at the end of 2010 and $12.4 billion in midyear 2011.

Even if you take out money market funds from the mutual fund count-since there are no ETF equivalents-the $1.1 trillion now held in ETFs compares to $8.7 trillion held in long-term stock and bond funds, notes Senior Research Analyst Loren Fox of Strategic Insight.

That puts in better perspective the inflows for ETFs versus mutual funds in the first half of 2011 (See "Investors Take Stock in Exchange-Traded Funds," page one).

All told, $55.8 billion flowed into ETFs in the first half. That's essentially half of the $108 billion that flowed into mutual funds.

But it's on an asset base that is just 12% as great as the mutual fund base.

That means ETFs are on pace for their fifth straight year of $100 billion or more in net inflows, Fox notes. "This is a testament to these products' remarkable flexibility and increasing diversity," he said. "ETFs can now be used to build full portfolios, and when demand for equity ETFs slows down, it seems demand for other types, either bond ETFs or commodity ETFs, picks up."

Strategic Insight expects exchange-traded funds to hit $2 trillion in assets under management by the end of 2015.

That, interestingly enough, will put ETFs behind the pace set by mutual funds. According to Investment Company Institute records, it took only four years, from 1990 to 1994, for mutual funds to go from $1 trillion to $2 trillion under management. By Strategic Insight's estimate, it will take ETFs five.

But the growth of ETFs is not entirely at the cost of mutual funds, Fox finds. "For one thing, roughly half of U.S. ETF assets are held by institutional investors who rarely used mutual funds to begin with," he said. "Second, we know that ETFs are frequently being used in place of individual stocks and bonds."

The nut nut: Investors are not selling their mutual funds to add to their ETF holdings. Instead, ETFs are simply "taking a share of incremental growth away from mutual funds,'' Fox contends.

Both can-and will-co-exist. And both will continue to grow. They'll just get used for different purposes.

An argument can be made that mutual funds are for "passive" investors, who just want to contribute a portion of their income into savings and forget about it, while ETFs are for more active investors, who want to be able to cut and run, at a moment's notice.

That may be. But, if you're not an institution or a professional trader, a few hours do not make much difference.

Unless high-speed trading somehow leads to more Flash Crashes and everybody decides they need complete liquidity on all investments. But circuit breakers and limits up and down on stocks should remove that concern.

Long live mutual funds and ETFs, side by side. MME