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The ETF industry is ready for its close-up, but the masses are still stuck in fee-laden mutual funds.
Total U.S. ETF assets reached a $1.5 trillion milestone earlier this month—they’re at a record $1.537 as of this morning—and it won‘t be too long before they hit $2 trillion. Still, don’t hold your breath.
On the one hand, asset gathering in the ETF industry is accelerating, as investors and advisors wake up to advantages of ETFs including low costs, intraday tradability and tax efficiency. The amount of money pouring into ETFs so far in 2013 is coming at a fast-enough pace to erase last year’s record of $188 billion.
Indeed, it’s taken 2 1/2 years for total assets to get from $1 trillion to $1.5 trillion after it took nearly 18 years to reach the $1 trillion milestone.
It all began in January 1993 with the launch of the launch of the SPDR S&P 500 ETF (NYSEArca: SPY). The original designers of SPY thought the ETF would appeal only to traders; indeed, it was initially designed to bring new trading volume to the American Stock Exchange. They thought $1 billion in assets would make it a success.
SPY is now the biggest and most liquid exchange-traded fund in the world, and its $143 billion in assets make up more than 9 percent of the $1.537 trillion industry total, according to data compiled by IndexUniverse.
A lot has changed since the SPY launched in 1993, especially the money management industry itself. In these last 20 years, stock pickers have been surpassed by fee-based asset managers using low-cost vehicles such as ETFs as the best way to deliver asset allocation and solid risk-adjusted returns at the right price.
Some of the money going into ETFs in recent years has come out of actively managed mutual funds—equity funds, to be precise—making the rise of the ETF a zero-sum game, to some extent. It seems likely that the same reversal of flows will start to happen with bond ETFs as well, as IndexUniverse President of ETF Analytics Dave Nadig has said.
The shift into an ETF wrapper from whatever other investment vehicle makes perfect sense in retirement accounts, such as IRAs.
ETFs also would make a lot of sense in 401(k)s. That huge piece of the retirement market is dominated by relatively expensive mutual funds, and is notoriously larded up with all kinds of fees that plan participants have no idea about.
Charles Schwab has said it will roll out a 401(k) platform designed with ETFs in mind, and when this becomes reality, the floodgates of inflows into ETFs could really open up.
For the record, of the $13 trillion currently in mutual funds, $5.3 trillion is invested in IRAs and 401(k)s and 401(k)-like “defined contribution” plans, according to data from the Investment Company Institute (ICI).
But regarding IRAs, I’ll go out on a limb and make it plain: Any advisor who doesn’t invest the bulk of a client’s tax-protected retirement assets in index funds such as such as ETFs might well be guilty of a dereliction of duty.
After all, since advisors generally agree that individual security selection is less important to returns than is proper asset allocation, then why on Earth would any IRA owner be invested in a more expensive mutual fund when they can switch to an index fund without any tax consequences whatsoever?