Fiduciary rule soon could make ETFs even hotter

ETFs were on a roll even before the fiduciary rule rolled out this year. Now they could see a bump up in demand as more advisers focus on reducing costs for investors.

Exchange-traded funds are cousins to traditional mutual funds but offer more trading flexibility and other potential benefits. They're popular among relatively affluent investors and people comfortable with risk.

Like mutual funds, ETFs invest in all sorts of things — American and foreign stocks, specific industry sectors, high-dividend companies, bonds, commodities and more. "There is an ETF offering exposure to virtually every fine slice of every asset class, every strategy and every theme under the sun," wrote Ben Johnson, an ETF research director at Morningstar, in a commentary.

In a July survey of more than 900 investors conducted by E-Trade, respondents expressed the most interest in ETFs that track U.S. stock-market indexes such as the Standard & Poors 500. ETFs owning high-dividend stocks were second in popularity, followed by those that hold companies in specific sectors such as technology, finance and energy.

Alan Rosenfield of Harmony Asset Management in Scottsdale, Ariz.,  likes the transparency of ETFs — portfolio holdings typically are disclosed on fund websites daily — as well as the ability to round out a portfolio. "They're good for plugging gaps in a portfolio, especially in areas where you lack expertise — whether in biotech, oil, banks or whatever — and don't want to buy individual stocks," he said. As an example, Rosenfield said he's currently using an ETF to bet against the price of oil.

One key difference between regular funds and ETFs is in the way investors buy and sell. ETF shares trade at various prices throughout the day. They also can be sold short or bought on margin using borrowed money, like regular stocks. Mutual funds, by contrast, are sold through various channels and priced  just once a day, meaning you'll get the end-of session price whether you place your order in the morning or afternoon.

One caveat Rosenfield cites is the potential for EFT shares to trade with a lot of volatility as big traders could push prices up or down. Such volatility is usually short-term, "but it might come exactly when you want to get out," he said.

ETFs tend to charge lower fees than mutual funds, reflecting the fact that most are passive portfolios that merely try to match the performance of various stock or bond indexes, eliminating the research costs and other expenses that go with active management.

They also tend to be more tax-efficient because ETFs hang onto their stock and bond holdings for extended periods, triggering fewer portfolio profits that get passed along to shareholders as capital gain distributions. "Less buying and selling results in fewer taxable events — it's really that straightforward," noted Johnson at Morningstar. Mutual funds are much more likely to make taxable distributions.

Cost reduction is a primary aim of the fiduciary-standard rules approved by the Labor Department this year. More advisers will have to put client interests first and avoid conflicts of interest. It thus can help to recommend low-cost ETFs.

Many investors already have gravitated to funds that keep expenses down. According to Morningstar, the 100 largest ETFs, which account for 74% of all assets, charge average expenses of just 0.22% a year, or $2.20 for each $1,000 invested. Expenses for the other 1,700-plus ETFs average 0.55%.

The typical mutual fund charges 0.68%, reports the Investment Company Institute, down from 0.91% a decade ago.

Some media reports estimate ETF assets might jump by $1 trillion to $1.5 trillion because of the new fiduciary-standard rules. That's hard to say, but they have been growing steadily. The nation had 1,646 ETFs worth a combined $2.2 trillion as of May, according to the Investment Company Institute. That was up from $2.1 trillion spread among 1,465 funds a year earlier.

Mutual funds remain much larger, with $15.9 trillion in assets as of May, but they've been around a lot longer, too. ETFs debuted in the U.S. in the early 1990s.

Reach the reporter at russ.wiles@arizonarepublic.com or 602-444-8616.

ETFs appeal to risk-tolerant investors

People who buy exchange-traded funds tend to be more affluent than mutual fund investors and are generally willing to take larger risks. Here are some comparisons, according to research from the Investment Company Institute:

• ETF buyers report an average household income of $110,000 and  net worth of $375,000. Some 53% of these investors describe themselves as willing to accept above-average or substantially more risk for higher returns.
• Mutual fund buyers report an average household income of $87,500 and net worth of $200,000. Only 31% describe themselves as willing to accept above-average or substantially more risk.

Note: Net worth figures exclude households'  primary residence.