Once a mere curiosity, ETFs now outshine mutual funds

Advisers are taking note of the transparency, lower fees

By David Hoffman

Jun 9, 2008 @ 12:01 am (Updated 2:46 pm) EST

Exchange traded funds were an oddity at the start of the decade. Today, many financial advisers view them as indispensable tools that outshine mutual funds.

"The advantages over mutual funds are clear," said Marvin Appel, chief executive of Appel Asset Management Corp., a Great Neck, N.Y., firm that manages $50 million in assets.

Compared with many mutual funds, ETFs are more transparent and less expensive, he said, adding that they can be traded throughout the day an added benefit.

Those advantages had seen the investment type grow to 629 ETFs with $608.42 billion in assets at the end of 2007, up from 29 ETFs with total assets of $15.56 billion in 1998, according to the Investment Company Institute, a mutual fund trade group in Washington.

The history of ETFs dates back to 1993, when the American Stock Exchange in New York listed the Standard & Poor's Depository Receipts Trust Series 1 (SPY), or "Spider," which is managed by State Street Global Advisors of Boston.

But ETFs didn't really start to get going until March 1999, when the Nasdaq 100 Index Tracking Stock (QQQQ) better know as the "Cube" was launched by The Nasdaq Stock Market Inc. of New York.

In March 20007, Nasdaq transferred sponsorship of the ETF to Invesco PowerShares Capital Management LLC of Wheaton, Ill., and the name was changed to the PowerShares QQQ.

In May 2000, Barclays Global Investors of San Francisco launched its first four iShares ETFs.

Today, Barclays is the largest ETF provider as measured by the number of ETFs and total assets. As of April 30, it offered 159 ETFs with a total of $320.41 billion of assets.

It was apparent almost from the beginning that Barclays had a hit on its hands, said Herb Blank, president of QED International Inc. of New York, an industry consultant.

That caught the attention of other industry players, particularly The Vanguard Group Inc. of Malvern, Pa., he said, adding that Barclays' ETFs were direct competition to Vanguard's index funds.

Vanguard's first ETF, launched in May 2001, was actually a share class of an established Vanguard fund: the Vanguard Total Stock Market Index Fund. Today, Vanguard is the third-largest ETF provider by assets. It had $47.99 billion spread across 37 ETFs as of April 30.

The ETF industry became a hotbed for innovations. One of the most innovative companies was Invesco PowerShares.

"I think you have to give PowerShares their due," said Jeff Ptak, director of exchange traded securities analysis at Morningstar Inc. of Chicago. The company's first two ETFs, called PowerShares XTFs, were launched in May 2003.

They were unique because they offered elements of active management without actually being actively managed.

The PowerShares ETFs opened the floodgates to all kinds of unusual indexes from myriad providers.

WisdomTree Investments Inc. of New York in June 2006 launched ETFs that follow "dividend-weight indexes." The ETFs select securities in each index based on the amount of cash dividends that companies in each index pay or the dividend yield of the companies in each index.

A slew of other fundamentally weighted ETFs would follow, and with them debate about whether they were an improvement over traditional market-cap-weighted indexes.

There would soon be other developments, such as ETFs giving investors access to commodities, and ETFs providing short exposure to an underlying index.

In April, Invesco PowerShares launched the first truly actively managed ETFs to invest in stocks, perhaps signaling a new era for ETFs.

E-mail David Hoffman at dhoffman@investmentnews.com.