Don't Count Out Index Mutual Funds

August 11, 2009

While ETFs have grabbed most of the spotlight in recent years, index mutual funds still hold a bigger share of the open-end funds marketplace.

 

Exchange-traded funds have enjoyed a nearly uninterrupted rise in popularity during the past decade. But so have their cousin index mutual funds.

At the end of 1998, ETFs had just $13.7 billion in assets. By last year, those were up to nearly $534 billion. That’s a pretty impressive run, especially considering that last year represented the first net fall in assets for the industry.

By contrast, actively managed mutual funds have actually been losing market share since 1998. At the same time, index mutual funds have more than doubled their asset base. In fact, through the end of July, Morningstar data showed index mutual funds with 9.52% of the open-end fund industry’s assets. ETFs, meanwhile, held some 8.93%.

The slight lead by index mutual funds over their largely index-based ETF rivals might not seem surprising, given mutual funds’ huge head start. After all, active mutual funds still control roughly 81.56% of the total market. Consider the table below depicting the growth in net assets by each type of fund:

 

Year

Exchange-Traded Funds

Index Mutual Funds

Active Mutual Funds

1998

$13.7 billion

$245.1 billion

$3.1 trillion

1999

$23.1 billion

$362.9 billion

$3.9 trillion

2000

$35.3 billion

$358.5 billion

$3.8 trillion

2001

$49.8 billion

$347.6 billion

$3.6 trillion

2002

$102.1 billion

$305.1 billion

$3.3 trillion

2003

$151.6 billion

$425.3 billion

$4.2 trillion

2004

$228.1 billion

$522.6 billion

$4.9 trillion

2005

$298.7 billion

$586.8 billion

$5.5 trillion

2006

$416.8 billion

$719.8 billion

$6.6 trillion

2007

$612.6 billion

$845.6 billion

$7.6 trillion

2008

$533.9 billion

$596.0 billion

$4.9 trillion

Source: Morningstar Inc.

 

But net assets don’t always provide the best view of fund trends. Assets are the combination of appreciation and how much money goes in and out of portfolios. Last year, when the market got pummeled, a big part of lower asset levels came from losses in stock and bond values in the market.

Net inflow data provide a better sense of investment sentiment. Look at what those numbers showed in the past 10 years through 2008:

 

Year

Exchange-Traded Funds

Index Mutual Funds

Active Mutual Funds

1998

$5.1 billion

$42.5 billion

$158.2 billion

1999

$6.1 billion

$56.7 billion

$101.8 billion

2000

$12.6 billion

$16.7 billion

$176.4 billion

2001

$18.5 billion

$22.6 billion

$122.9 billion

2002

$39.9 billion

$20.9 billion

$144.4 billion

2003

$13.2 billion

$33.9 billion

$226.9 billion

2004

$50.9 billion

$42.0 billion

$235.9 billion

2005

$51.3 billion

$23.3 billion

$251.9 billion

2006

$59.9 billion

$39.7 billion

$365.4 billion

2007

$139.7 billion

$68.9 billion

$313.6 billion

2008

$157.2 billion

$42.8 billion

-$143.5 billion

Source: Morningstar Inc.

 

Index and active mutual funds suffered slowdowns in the tech wreck years. It took until 2003, when markets actually rebounded, before flows chilled in ETFs. The other two fund types were already heating up, however.

After 2003, ETFs took off again and even managed to gain more creations than redemptions last year. But as markets cooled in 2005, so did index fund flows. Perhaps the rather shallow pullback gave investors confidence that managers could squeeze a bit more out of stocks than their respective benchmarks. Indeed, after double-digit returns the previous two years, the SPDR S&P 500 Index ETF (NYSEArca: SPY) gained 4.9% in 2005. The next year, it resumed moving forward by adding another 15% for that 12-month period.

 

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