ETFs have been available in the United States since 1993 and are an alternative to mutual funds that trade just like stocks. But a decision earlier this year from the U.S. Securities and Exchange Commission could broaden their appeal even more.
An ETF is a "basket" of stocks that by itself trades on an exchange just like an individual stock. ETFs contain the assets of large or small companies, real estate investment trusts, international stocks, bonds and even gold.
For instance, an investor can buy every stock of the S&P 500-under the SPY ticker symbol-with one purchase rather than individually buying certain shares on the index. The advantage is exposure to the entire market without assuming the risk of a single stock.
That's particularly important in today's volatile market, said Keenan Hauke, CEO of local money manager Samex Capital Advisors. Purchasing a broker-dealer ETF would make more sense than separately buying shares of, say, Lehman Brothers or Goldman Sachs.
"You lost money, but you didn't get wiped out," he argued.
Many of Hauke's colleagues share his excitement. Sixty-seven percent of 840 wealth managers identified ETFs as the most innovative investment vehicle of the last two decades, according to a survey this year from State Street Global Advisors in Boston and The Wharton School at the University of Pennsylvania.
And 60 percent said ETFs have changed the way they build investment portfolios.
The number of ETFs has grown to roughly 600, trading a combined average of more than a billion shares a day. Cost, trading and tax advantages make them an attractive investment option.
Like stock purchases, ETFs require little broker oversight, which translates into cheaper fees. Annual fees for ETFs are as low as 0.09 percent of assets, compared with the typical mutual fund fees of 1.4 percent. Like a stock, though, ETF investors still must pay a commission.
Another big difference between mutual funds and ETFs is the way they are traded. ETFs can trade midday while mutual funds cannot. Traditional mutual funds take orders during trading hours, but the transactions actually occur at the close of the market. The price they receive is the sum of the closing-day prices of all the stocks in the fund. In contrast, ETFs trade throughout the day and allow an investor to immediately lock in a price for the stocks.
But the SEC decision bridges some of the differences between mutual funds and ETFs by allowing ETFs to be actively traded like mutual funds. In the survey conducted by State Street and The Wharton School, 27 percent of planners think actively traded ETFs present the greatest potential for ETF growth.
Others aren't so sure. That's because the majority of traditional mutual funds don't even beat the market, and most actively managed ETFs likely won't either, experts say.
Samex Capital has no plans to buy or sell active ETFs and instead is sticking with traditional versions that Hauke thinks ultimately could become the preferred method of investing.
"The performance of the mutual funds is miserable compared to the benchmark," he said, "which is why they're ready to be put out to pasture."
Still, investors should be careful when considering investment options, said Juli Erhart-Graves, president of locally based Worley Erhart-Graves Financial Advisors. She likes the diversification ETFs offer, but doesn't recommend them to all clients.
"My biggest warning is that they shouldn't be used over mutual funds in every situation," she said.
Chris Cooke, managing director of investments at locally based Cooke Financial Group, expressed caution as well. He said ETFs should not be viewed as a "panacea" for investors.
"What's in the basket is what counts," he said. "It depends on what basket you're buying. It may not be as diverse as you think."
While only 27 percent of planners are encouraged by the potential for actively traded ETFs, even more-43 percent-think the future of ETFs is in 401(k) plans.
Hauke has established a 401(k) plan using ETFs and could be the first adviser in the state to do so. Concept Packaging & Design, a distributor of custom packaging products in Long Beach, Calif., is his only client to so far to test the waters. Calls to the company were not returned.
Pension plans are a $4.5 trillion business, and ETF providers consider the area to be the last untapped market for the funds. Their low cost and fee transparency are attractive fits for 401(k) plans.
The hurdle that keeps ETFs from retirement plans is that they're traded throughout the day, like stocks, making seamless recordkeeping difficult.
Though Hauke is not about to push the option on employers, he considers ETFs an "absolute no-brainer."