Chart of the Day: A New Breed of ETFs Threaten Mutual Funds

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Published on Friday, 29 June 2012 08:00

Written by Adam English, Associate Editor, Inside Investing Daily

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A whole new breed of ETFs has emerged in the past couple of years that is poised to take on the staple of American retirement plans -- actively managed mutual funds.

Most ETFs mirror a passive index or sector. These new funds, though, are actively trying to outperform the market by introducing useful metrics to the indexing process.

First Trust Health Care AlphaDex Fund (FXH:NYSE) weighs U.S. healthcare stocks based on a proprietary mix of financial measures such as sales growth and return on assets.

PowerShares DWA Technical Leaders Portfolio (PDP:NYSE) evaluates relative strength and generally follows the advice Dorsey, Wright & Associates Inc. uses for its clients.

Pimco Total Return Exchange-Traded Fund (BOND:NYSE) is simply an ETF built on Bill Gross' investment picks in fixed-income securities.

All three track an index... like passive ETFs. This new breed, however, is based on a mix of ever-changing fundamentals, which leads to a high level of churn. Shares are constantly moving in and out of the fund.

The idea is a direct threat to actively managed mutual funds. In addition to lower fees and tax benefits, investors can easily move in and out of positions in these fresh ETFs. The expensive and slow system mutual fund managers built is hopelessly outclassed.

The funds are winning converts, too. ETFs and index mutual funds together attracted $173 billion in 2011 while actively managed mutual funds lost $31 billion to withdrawals.

Mutual fund managers enjoyed a virtual monopoly and built their funds to make investing easy and profitable... for themselves -- not their clients.

Hopefully, this new breed of reactive ETFs will convince investors that actively managed mutual funds are a thing of the past.