The article also observes that the number of index OEFs and ETFs is about the same, but that ETFs cover five times as many indexes. Moreover, the article points out that newer ETFs tend to track indexes that are less liquid, more volatile and more heavily concentrated in a single industry. Such indexes are more appropriate for an ETF structure than they are for an OEF structure, which would likely experience high tracking error.

This would seem to be part of the reason for the growth of sector and emerging markets investing. Although the article is focused on OEF and ETF structures, it can be extrapolated that ETFs have opened up investors' opportunity sets significantly.

In an interesting aside, the authors suggest that actively managed ETFs might be an ill-conceived idea, citing evidence that the OEF structure allows investors to reward manager ability by voting with their feet. However, I fail to see why a similar trend would not be possible with actively managed ETFs. After all, if active ETFs are managed poorly, investors will simply trade them at discounts to their actual worth or not trade them at all. And, in theory, new shares will not be created either. Mainly, the great virtue of the article is that it offers some quantitative proof for something we already kind of knew—that ETFs appeal to a great many people, but that OEFs are more suited to certain specific groups of investors, and primarily the risk-averse small investor.

Costs Less Important

Usually the example that is cited involves costs, not liquidity shocks: Trading costs associated with ETFs may wipe out their advantages for smaller investors who may be dollar-cost averaging their investments or using a similar strategy. For those investors, OEFs are by far the better choice. But with the advent of no-commission ETF trading, costs are slowly becoming less of a factor for small individual investors.

In light of these more recent market developments, the Guedj and Huang article provides another dimension. They highlight the fact that ETFs are growing in popularity not just because of their "stock-like" characteristics but because they can more efficiently offer exposure to more asset classes and sectors than OEFs.

Extrapolating from Guedj and Huang's conclusions, a person familiar with the ETF industry would conclude—as many already have—that while index-tracking OEFs will not face extinction, they are unlikely to grow any further as an industry, and it is only a matter of time before they are dwarfed by the ETF industry.

Heather Bell is assistant editor at IndexUniverse.com. She can be reached at: This e-mail address is being protected from spambots. You need JavaScript enabled to view it .

1 | 2 |