BOSTON -- Exchange-traded funds remain relative upstarts compared with mutual funds. But they're leading the race for investors' assets, on Main Street as well as Wall Street.
Check out the key ETF trends of 2012, and it's not a stretch to ask whether investors might someday commit as much cash to ETFs as they have to their more established cousins.
Introduced in the early 1990s, ETFs initially were trading tools for professional investors. Similar to low-cost index mutual funds, they track segments of the market and try to match a benchmark stock or bond index rather than beat it. But ETF shares can be traded throughout the day like stocks. That makes it possible to lock in a preferred price without waiting for a closing price. Mutual funds are priced only at the close of daily trading.
Here's a look at 6 ETF trends that are likely to continue playing out in 2013:
1. Increased acceptance on main street
Although ETFs remain better-known on Wall Street, their low costs and index investing approach are drawing more average investors. Individuals own about 60 percent of assets in ETFs. The remaining 40 percent attributed to institutional investors like pension funds and foundations, according to a recent study by consulting firm Strategic Insight.
2. Outpacing mutual fund growth
ETF assets have doubled over the past three years, reaching $1.3 trillion. They continue to grow at a faster pace than mutual fund assets. So far this year -- with more than $150 billion in net deposits through November -- ETFs are on track to match a 2008 record for the amount of new cash taken in, according to Morningstar. However, for every dollar in an ETF, investors have stashed $7 in mutual funds. So there's still plenty of ground to make up. ETF assets are projected to nearly double to almost $3.5 trillion by 2016, according to a study by Cerulli Associates. So with their faster growth rate, it's not hard to fathom ETFs someday rivaling the current $8.9 trillion in mutual fund assets.
3. Competitors cutting costs
A key appeal of ETFs has been the lowering of their fees. Several industry leaders have recently cut ETF expense ratios -- the amount paid to cover operating costs, expressed as a percentage of assets. Investors need to consider much more than costs, but the recent reductions are a clear positive. Charles Schwab, a relatively small player in ETFs, made a particularly bold move in September. It reduced expense ratios at two stock ETFs to 0.04 percent, or $4 a year for every $10,000 invested. That's the lowest in the industry, and also undercuts the fees that individuals pay at index mutual funds.
The biggest ETF provider, BlackRock's iShares unit, followed Schwab's move by cutting fees at six of its largest ETFs in October. Meanwhile, Vanguard has reduced fees at two-thirds of its ETFs over the past 14 months. More trims are expected as a result of a move that will reduce overhead costs. Vanguard is in the process of switching the market indexes that 22 of its ETFs and mutual funds track to benchmarks provided by companies that will charge lower licensing fees.
4. BOND ETFs sURGING
Increasingly risk-averse mutual fund investors have deposited huge sums into bond mutual funds since the 2008 financial crisis. Bond ETFs also are enjoying strong growth. This year, they've attracted $52 billion in net deposits through November, reaching a total $245 billion in assets, according to Strategic Insight.
Some $3.5 billion has flowed into just one bond ETF. The Pimco Total Return ETF (BOND) was launched in March, and it's expected to surpass $4 billion in assets this month. It owes much of its initial growth to the star power of its manager, bond trader Bill Gross. The new product is an ETF version of his Total Return mutual fund, the world's largest, which has also seen a surge of cash come in this year. The ETF and mutual fund versions pursue essentially the same investment strategies, although regulatory restrictions prevent the ETF from investing in futures, options or swaps.
5. Becoming more active
Pimco's new ETF is among a small but growing number of actively managed ETFs that seek to outperform the market, rather than match an index. Managed ETFs represent a small fraction of overall ETF assets, but they're growing fast. Among the big industry players making moves into managed ETFs are State Street's "SPDRs" ETFs family and Fidelity Investments. State Street debuted its first three managed ETFs in April, and Fidelity this month filed a regulatory application to launch its first such products.
6. Only the strong survive
Despite industry-wide growth, many ETFs aren't attracting enough cash to remain financially viable. In fact, it's been a record year for ETF closures. Through November, 101 ETFs had closed, according to S&P Capital IQ. Although more have been launched than closed, the number of ETFs shut down this year is nearly four times the total that closed in all of 2011.
Among the 1,200 ETFs on the market, there's a big gap between the biggest and smallest in terms of assets. About four-dozen ETFs account for about two-thirds of all ETF assets. The largest, the SPDR S&P 500 (SPY), has about $114 billion. Most of those closing had less than $10 million. "Some of the smaller providers," says S&P analyst Todd Rosenbluth, "have gotten religion, and realized they can't keep products out there if they're too small and aren't growing."