The Case for ETFs Over Mutual Funds Gains Steam

Cerulli report shows ETFs are the top choice among portfolio construction tools.

The financial planning industry’s preference for exchange-traded funds—following a mid-year inflow surge—is not expected to wane any time soon, according to the latest research from Cerulli Associates. 

While mutual fund usage still overshadows the ETF market and will likely continue to do so until the menu structure of defined benefit plans changes, ETFs have the momentum on their side. 

Cerulli’s October product trends report highlights the usual reasons financial advisors cite for finding ETFs appealing: low fees, liquidity and tax efficiency. But as the ETF space evolves beyond passive indexes to actively-managed, fully transparent strategies, the odds are stacking up against legacy mutual fund companies. 

The trend can be seen in mutual fund to ETF conversions, filings to create ETF share classes and the wave of mutal fund complexes making late moves into the space over the past few years. 

According to the Cerulli report, financial advisors and other professionals managing portfolios described ETFs as the largest area of opportunity among investment vehicles. 

ETFs Take the Top Spot 

Cerulli analyst Matthew Apkarian, CFA said this is the first time ETFs have occupied the top spot, taking the lead over institutional separate accounts. 

“There’s a proliferation of active ETFs; that’s the major story now,” he said. “Every asset manager is working on product development in active ETF wrappers.” 

Apkarian confirmed that the findings spell “bad news for mutual funds, for sure.”  

“But they still have a stranglehold on 401(k) plans and play a large part in managed account platforms,” he noted. 

Matthew Garasic, CFP, founder and president of Unrivaled Wealth Management, has a long list of reasons to use ETFs over mutual funds. 

“Unless there’s a specific asset class I can’t access through an ETF, client portfolios are comprised entirely of passively managed ETFs,” he said.  

He cites the potential tax consequences mutual fund investors face when other investors redeem their shares. 

“The fund manager must rebalance the fund to accommodate those redemptions,” he said. “These sales generate capital gains or losses that are passed onto shareholders regardless of whether they personally sell shares.” 

Some Advisors Cling to Mutual Funds 

Of course, not all advisors have climbed aboard fully on board the ETF bandwagon. 

Daniel Lash, CFP, AIF, partner and financial advisor at VLP Financial Advisors, still uses mutual funds for sectors where he sees outperformance opportunities for actively-managed strategies. 

“Those sectors are fixed income and international equities that some, not all, active strategies will outperform passive ETFs,” he said. “We also will utilize active mutual funds that provide similar passive performance with risk lower than the passive index.” 

Carla Adams, CFP, founder of Ametrine Wealth, said she gets faster settlements with mutual funds, compared to ETFs. 

“If a client of mine needs money ASAP and I need to sell funds, by selling mutual fund assets instead of ETFs, I can get them the money one day sooner,” she said. “This can be key to avoid going on margin, especially for accounts where margin is not setup or not possible.” 

Meanwhile, Adams admits she is “primarily using ETFs for clients these days, but many of my clients still do have mutual funds in their portfolios. 

“Particularly for clients that have come to me multiple times in the past needing cash with little notice, I do keep mutual funds in their accounts so that I can get them money one day sooner if and when they come to me with a short notice cash need,” she added. 

Per the Cerulli data showing ETFs bumping separate accounts out of the most preferred spot, Apkarian said that doesn’t suggest ETFs are overtaking SMAs. 

“Just because ETFs jumped ahead of SMAs by level of growth and opportunity doesn’t mean they threaten separate accounts,” he said. 

Unlike mutual funds and ETFs, which have mass market appeal, SMAs are generally more popular with wealthier clients and those with more complex tax circumstances. 

He added: “You can better tax manage with SMAs, but ETFs are cheaper. There’s some overlap with SMAs and ETFS, but so far they’re targeting different client segments that are mainly distinguishable by net worth and income level.” 

Contact Jeff Benjamin at [email protected] and find him on X at @BenJiWriter.