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Page 1 of 5 The exchange traded fund structure will eventually prevail for actively managed equity funds because it is inherently more efficient than the traditional structure, benefiting both investors and fund providers. In brief, the structure insulates the fund from daily cash flows and allows the fund to accept holdings into the fund (and deliver them out) without incurring transaction costs. The result is that managers can Interestingly, taxable investors who prefer active management will improve their after-tax-and- fee net returns far more on a relative basis than their index-investing brethren. Providers of such services will be able to deliver superior returns and superior structural utility to their investors while significantly cutting internal costs. However, these benefits will only accrue to providers willing to modify their current methods and procedures. ETFs' Ironic Benefits ETFs got their initial foothold in popularity with large tax-exempt institutions utilizing them primarily as trading vehicles. Since then, their popularity has extended to other active trading participants, such as day traders and hedge funds. More recently, ETFs have also been increasingly utilized by: buy-and-hold institutions; family offices; registered investment advisors; financial planners; and high-net-worth individuals. These constituencies are motivated by the ability of many ETFs to offer increased tax efficiency, market accessibility and utility, coupled with the expectation of achieving above-average after-tax rates of return. Given ETFs' initial association with trading applications, it is ironic that the most pro-found changes that the structure's evolution will eventually bring about are to typical, buy-and-hold, mutual fund investors. This is because, quite apart from any active trading strategies, the basic ETF structure is poten-tially far more beneficial to taxable holders of actively managed funds than to any other Nevertheless, despite these vast improvements in efficiency, challenges persist to the adoption of the structure by active managers. These potential obstacles must be addressed before widespread usage All this is important to the mutual fund industry, which in many ways appears to be at a crossroads. The past decade began with unprecedented prosperity and fund proliferation. It ended with some indications that the bloom is falling off the rose for the majority of providers. A 1995 survey by Mutual Funds magazine found the top two qualities sought by investors from their mutual funds were customer service and managerial experience. A similar survey published in September 2000 found the two most desired qualities to be above-average returns and tax efficiency. Fund transparency, a factor not even on the list in the 1995 survey, ranked fifth in 2000. This change reflects the extent to which investment information and technology revolutions have significantly impacted investor behavior. As CBS commentator Charles Osgood once put it, Investing has become the great American pastime. And, a major reason is the availability of information everywhere. In addition to awareness of the differences between reported rates of returns and taxable returns, investors are more fee-sensitive than ever before. They also tend to seek more extensive servicing, more diverse choices and increased transparency. This heightened awareness has translated into more comparative shopping among alternatives by taxable investors. Index funds have been a major beneficiary of these developments. |
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