The Curmudgeon

August 01, 2004

Bill Clinton relied upon the film The Man From Hope to schmooze the electorate in his 1992 presidential bid. Hope, in case you slept through the movie, is the rosy moniker of Bill's Arkansas hometown. Produced by veteran TV meisters and original-gang Friends-of-Bill Linda Bloodworth-Thomason and Harry Thomason, The Man From Hope was credited with turning around perceptions of the then-faltering Democratic candidate. By no small accident of geography was Mr. Clinton helped by this flick. Just imagine the title rethink required if the film's protagonist had been born in the snug hollow of Blue Ball, Ark., instead.

Arkansas , it turns out, is home to several arresting place names. Just ask your travel planner for directions to the far corners of the state and burgs like Toad Suck, Buffalo Lick and Oil Trough will likely pop up on your itinerary. The little border town of Success, however, may not be on your agent's radar screen. And no wonder. Success, at the last census, claimed a population of only 396 souls. The present size of the populace, however, belies the town's growth-a whopping 133% over the past decade.

Despite Success's apparent, um, success, its small population base makes this statistic suspect as an indicator of a sustainable trend. Likewise, critics of exchange-traded funds often disparage the new-fangled portfolios as quaint, but insignificant, collectors of assets. After all, they reason, assets in mutual funds number in the trillions; ETFs, only in the billions. And, indeed, with domestic assets amounting to only 2% of those stashed in mutual funds, ETFs are to mutual funds as Success is to, say, Bentonville.

Remember back in 2000 when Financial Research Corporation (in The Future of Exchange Traded Funds) predicted that ETF assets would grow to $500 billion by 2007? For that fearless prognostication to come true, ETF assets would have to grow nearly sevenfold from 2000 levels. By year-end 2003, domestically domiciled ETFs held assets of about $151 billion, a three-year pickup of 130%. Impressive? Yes, but growing by another $349 billion in just four years looks like rough sledding, especially in light of Westheimer's Time Estimation Rule. Any prediction of the time required to complete a task, says the rule, should be adjusted by doubling the original estimate and changing the unit of measurement to the next highest unit. Thus will your auto mechanic allocate two days of garage time for a one-hour job.

Applying the rule to FRC's estimate, the attainment of the half-trillion dollar asset mark should actually take ETFs 14 ... er ...uh ... 14 what? What's the next highest unit after a year? Congressional seatings? That translates into 28 years. Olympiads? That'd be 56 years. Decades? Seventeen-year cicada cycles?

Perhaps a clue can be gleaned from mutual fund history. Mutual funds didn't reach the $500 billion asset level mark until 1986, some 46 years after the Investment Company Institute began tracking market size.

Oddly enough, the ICI records for both mutual funds and ETFs start out at about the same level. In 1940, mutual funds held $450 million; ETFs, in their inaugural year, 1993, held $460 million in assets. From their nearly common starting points, however, growth trajectories differed mightily. ETF assets grew by a factor of 327 times in their first decade of existence, while mutual funds cranked out only a fourfold increase.

Obviously, the '40s ain't the '90s. For a more contemporaneous comparison, look at average fund growth. In another startling similarity, both the average ETF and the average mutual fund held $460 million in assets in 1993. Ten years later, the average ETF had grown 176% to $1.27 billion. The average mutual fund, in the meantime, increased only 98% to $910 million.

Whether FRC's prediction comes true remains to be seen. Clearly, though, ETFs, like our little Arkansas settlement, have enjoyed a modicum of success. In dealing with detractors, ETF manufacturers should keep in mind the words of the town's most lyric observer: 'The problem with success is all the cess you end up sucking.''

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