Five ETF developments for investors to watch in 2012

By Mark Jewell

AP Personal Finance Writer

BOSTON (AP) -- Total investments in exchange-traded funds surpassed $1 trillion last year. It's a significant milestone considering that ETFs were unfamiliar to most investors just a few years ago.

And the final tally for 2011 is likely to show that ETFs attracted more than $100 billion in cash for the fifth year in a row.

What's most impressive about that surge in ETF investing is that it came while stock mutual funds lost investors, with more making withdrawals than deposits.

It's likely 2012 will be another big year for ETFs, which continue grow in popularity as a low-cost way to invest in the stock, bond and commodity markets. Industry consultant Strategic Insight projects ETF assets will grow by another trillion dollars by 2016. That doubling in just four years, compared with the 18 years it took ETFs to hit their first trillion.

It sounds achievable to Jim Ross, head of State Street Global Advisors' "SPDRs," the second-biggest family of ETFs. A few years back, projections that industry assets would reach $1 trillion in 2011 seemed crazy to Ross. "And yet, they've proved to be on target," he says.

Ross has been there from the start, when State Street launched the first ETF in 1993, the stock index-tracking SPDR S&P 500. Today, it's the largest ETF, with $96 billion in assets, and ETFs have become part of the lexicon of American investors, Ross says.

Among other things, he cites the fact that ETFs are mentioned in some of E-Trade's talking baby advertisements -- television spots that have become fixtures during Super Bowl coverage.

ETFs are similar to index mutual funds. Both seek to match rather than beat the market by investing in a basket of stocks or bonds. A distinct feature is that ETFs can be traded throughout the day like stocks, unlike mutual funds that are priced only at the close of daily trading.

ETFs are still way behind mutual funds in assets. For every dollar invested in ETFs, mutual funds hold $11. But the gap is narrowing.

Here are five ETF developments that bear watching in 2012:

1. Declining costs:

As with index mutual funds, ETF fees are typically low because investors aren't paying professional managers to pick investments. Management expenses continue to decline, in part because of the growing role that index fund pioneer Vanguard is playing in ETFs. Vanguard is the largest mutual fund company, but it lags BlackRock's iShares and State Street in ETFs.

However, Vanguard's ETF market share is growing because it has pressured rivals by cutting ETF fees, just as it did with mutual funds. The latest move came in December, when Vanguard cut by as much as 20 percent the expense ratios for its ETFs tracking 10 industry sectors in the stock market.

2. Fidelity's role:

The second-biggest mutual fund company, Fidelity Investments, lags far behind Vanguard in ETFs, but could be on the verge of trying to play catch-up. Fidelity offers just one ETF, launched eight years ago. Its role in ETFs has been limited to offering its brokerage clients ETFs run by other companies, such as iShares.

But that could change soon. Last month, Fidelity applied with regulators to expand the types of ETFs it could offer. Even if Fidelity gets permission for a broader range of ETFs, it's uncertain whether it will launch more. A company spokeswoman declined to comment on any specific plans.

3. Small investors and ETFs:

One reason ETFs remain under the radar for many individuals is that they first caught on with big investors like hedge funds and pension funds, which use them as trading tools. But ETFs can also be held for the long-term, an idea that has recently been catching on with individual investors saving for retirement.

A report from Charles Schwab on its brokerage clients shows that about two-thirds of net ETF deposits for the 12 months ended Sept. 30 was cash invested by individual investors, rather than by professional investment advisers. In the preceding 12 months, individuals accounted for just over half of new ETF cash. So small investors are clearly becoming a bigger part of Schwab's ETF business. Other evidence that ETFs are becoming mainstream is their appearance in some 401(k) plan investment menus, and in 529 college-savings programs.

4. Bonds and ETFs:

About two-thirds of ETF assets are invested in stocks, but bond ETFs are growing at a faster pace. They attracted roughly as much cash as stock ETFs did last year. One reason is the increasing popularity of bonds compared with stocks, among average investors. Many investors -- including lots of retirees -- are wary of stocks because of their greater volatility compared with bonds.

Bond ETFs could get even more new cash because Pimco is expected to launch an ETF version of its Total Return bond fund this year. With $244 billion in assets, it's the world's largest mutual fund, and is commonly found in 401(k) plans. Pimco filed papers for the ETF version of Total Return last spring, but a launch date remains uncertain.

5. Active ETFs:

An ETF version of Pimco Total Return would also mark a big step forward for the small but growing number of ETFs that are actively managed, rather than tracking an index. The prospect of star bond fund manager Bill Gross running an ETF could prove attractive to many investors. However, active ETFs typically charge higher expenses.

Active ETFs represent a small fraction of overall ETF assets, and they add a layer of complexity. That's because ETFs' required daily disclosure of investment holdings could hamper a manager's ability to beat the market. The frequent disclosures (mutual funds disclose holdings monthly, or in some cases quarterly) create the risk that an ETF manager's trades could be mimicked by an opportunistic rival money manager. It's an issue regulators are still wrestling with as they consider applications to launch more active ETFs. But the applications keep coming. State Street's Ross, for example, says his company plans to expand its active ETF lineup.


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Published: Mon, Jan 9, 2012