ETF sponsors not exploiting the mutual fund scandal

The mutual fund scandal is likely to bolster the popularity of exchange-traded funds, but don’t expect to see many ETF sponsors revving up their marketing engines to take advantage of it.

With the mutual fund industry under siege for the first time in its nearly 80-year history, now would seem like the perfect opportunity for the ETF sponsors to begin hyping the benefits of their product, according to industry observers.

After all, ETFs are significantly less expensive than mutual funds and they can be bought or sold at any time in the trading day – a feature sure to win converts among investors scared off by daily headlines about how market timers may have hurt their mutual fund returns.

avoiding negativity

But major ETF sponsors, including officials at Barclays Global Investors in San Francisco and Boston-based State Street Corp., say they will refrain from launching aggressive marketing campaigns aimed at taking advantage of the mutual fund industry’s woes.

To be sure, ETF sponsors are playing up the virtues of their product. However, those virtues are being touted at industry conferences or in one-on-one conversations with financial advisers.

“Something highly visible would have that bashing-on-the-fund-industry feel, and I don’t think that would be appropriate,” says Lee Kranefuss, managing director and chief executive of individual-investor business at Barclays Global Investors, the dominant player in the ETF field.

“We just don’t see the need to change the marketing campaign to take advantage of short-term news. Our approach has always been to take the high road.”

ETF sponsors are quick to rattle off a list of reasons for not wanting to stir the pot. Some say it’s unrealistic to expect investors to jump to ETFs because of a “few bad apples” in the mutual fund industry.

Others say the ETF industry, whose $127 billion in U.S. assets account for less than 2% of the fund industry’s nearly $7 trillion, simply doesn’t have the money to spend on a lot of self-promotion.

“ETFs don’t have the big expense ratios and 12(b)-1 plans that mutual funds do to go out and promote their efforts,” says Gus Fleites, managing director of State Street Global Advisors’ adviser strategies group. “As a result, they tend to be the quiet giants of the industry.”

But ETF sponsors have another good reason to keep their mouths shut: conflicts of interests.

Indeed, almost all sponsors of ETFs are also big players in the fund industry, including Boston’s Fidelity Investments, the nation’s No. 1 fund company, and Vanguard Group Inc. in Malvern, Pa., the No. 2 player.

By pushing ETFs too aggressively, they run the risk of further damaging investor confidence in the mutual fund industry. More significantly, they risk steering mutual fund investors toward a significantly less profitable side of their business.

“A lot of these folks are different pockets of the same pants here,” says Dan Dolan, director of wealth management strategies for the Select Sector SPDR Trust, the Garden City, N.Y.-based marketing arm of Alps Financial Services Inc., a fund distributor in Denver.

“You’re not going to see anyone beating anybody up over this one. If you see any [advertising of ETFs], you will see it with a positive spin, one that doesn’t take a shot at the mutual fund industry.”

Gary L. Gastineau, a managing member at ETF Consultants LLC in Summit, N.J., says the ETF industry may also be abstaining from self-promotion for fear of inviting closer scrutiny into flaws with its own model.

Specifically, Mr. Gastineau says industry studies suggest the pre-tax performance of many of the most popular ETFs tends to lag that of mutual funds tied to the same index.

The reason, he says, is that ETFs tend to be less aggressive when it comes to recapturing some of the costs that occur when keeping up with changes made to their benchmarks.

“I suspect the ETF people don’t want to get into a knock-down, drag-out competition with the other index funds,” he says. “It’s not in the ETFs’ favor.”

Despite the lack of aggressive promotion, ETF sales appear to have spiked in the weeks following New York Attorney General Eliot Spitzer’s stunning allegations of improper trading practices at many major fund companies, according to preliminary evidence from various market sources.

At Barclays, for example, $1.7 billion in new cash made its way into ETFs during the month of September, up from net outflows of $1.3 billion in September 2002. The company blames much of last year’s outflows on a withdrawal by one investor.

Still, during the first 17 days of October, $1.09 billion poured into Barclays ETFs, up nearly 13% from $969 million in the comparable period a year earlier.

As of Oct. 17, ETF assets stood at an all-time high of $127.3 billion, according to Mr. Dolan, who cites data he received from the American Stock Exchange in New York. That compares to $118.8 billion on Sept. 26 and $116.7 billion on Aug. 29, he says.

“The events surrounding the mutual fund industry are bad for investor confidence,” says Jeffrey T. Seely, chairman and chief executive of ShareBuilder Corp., a Bellevue, Wash., discount brokerage house that allows investors to purchase fractional shares of stocks, ETFs and index and bond mutual funds.

“But, as it relates to the exchange-traded funds, it will have a positive effect. I think it will draw more attention to this instrument as a viable alternative for investors.”

volume is up

Mr. Seely has noticed a significant increase in investments in ETFs at his company. For the week ended Oct. 17, 44.6% of the dollars being invested in the top-10 securities that were traded went into ETFs, up from 36% in the first week of September, he says.

Mark Balasa, co-president of Balasa Dinverno Foltz & Hoffman LLC, a Schaumburg, Ill., firm that oversees $600 million, says the mutual fund debacle has reaffirmed his belief in ETFs.

“I don’t know if [the scandal] is going to change our acceptance of ETFs,” he says.

“But it definitely reinforces my conviction that ETFs are good for us and for clients. The shenanigans and double-dealing that have been highlighted over the past couple of months just aren’t a part of the ETF world.”