Mutual Funds’ Dirty Little Secret
Listen to The ETF Store Show every Tuesday at 9am on ESPN 1510 as we cover everything you need to know about Exchange Traded Funds and the world of investing.
On our most recent radio broadcast, we discussed a dirty little secret that the mutual fund industry would prefer to keep quiet. While this practice isn’t new, additional attention was brought last week to the fact that a number of mutual funds are actually investing in ETFs. That’s right. A number of those expensive, actively managed mutual funds that you thought were shrewdly picking individual stocks and bonds are instead using some of your money to simply invest in ETFs. For example, recently, the single largest holding in the nearly $1 billion dollar Columbia Small Cap Core mutual fund (ticker SSCEX) was none other than the iShares Russell 2000 ETF (ticker IWM). The ETF was the top holding! This may come as a shock to some investors when they consider that they’re paying a high priced mutual fund manager good money (in this case – the fund has a whopping 1.4% expense ratio) to invest in ETFs. Now, at The ETF Store, we actually might consider this fund manager wise for investing in ETFs. The problem with this approach is that there’s no need to pay 1.4% (plus the expense ratio on the underlying ETFs) to have a mutual fund manager invest in ETFs. The iShares Russell ETF has an expense ratio of .2% on its own – seven times cheaper than the mutual fund! Why not just invest directly in the ETF?
We explained how mutual fund managers like ETFs for all of the same reasons we do. Namely, that ETFs are low cost, liquid, provide targeted exposure to a wide variety of benchmarks indices, and will generally deliver the performance of those benchmarks – something that mutual fund managers have had a devil of a time doing. Mutual fund managers know that as long as their mutual funds deliver something close to the benchmark returns, they have a job and will get to keep their outsized salaries and other perks. Why risk that trying to actively pick stocks and bonds when you know the odds are against you? This practice is actually pretty clever if you think about. The mutual fund manager uses the ETF to get the performance that they need and then will use the mutual fund wrapper to justify charging higher fees to investors. This should certainly raise some eyebrows and if nothing else, serve as a ringing endorsement of ETFs. If you can’t beat them, join them.
We also discussed what’s been driving the most recent bounce in the equity markets along with the surge in gold during our weekly market update. Finally, our weekly ETF spotlight featured a very interesting country specific ETF (ticker TUR) that has seen staggering returns so far this year. Listen to the full show here.