Sector ETFs Put Heat on Select Funds

Sector-specific exchange-traded funds are a hit with investors, but they could strike a sour note for select mutual funds.

"God gave investors select funds, and it was good. But on the sixth day, he made ETFs and it was very good," quips Neal Frankle, president of financial planning firm Wealth Resources Group.

ETFs originally started as a means to track market indices, but now track everything from specific industries to currencies to commodities. Select mutual funds provide a similar focus on one market segment.

"As time goes on and more ETF products are introduced to the market, they will threaten select funds. We could see it happen soon if ETFs that concentrate on the military, electronics and gold take off," Frankle says.

"With ETFs, you can get in and out of them immediately without having to pay a redemption fee for selling too soon," he adds. "The expenses are lower, you can trade throughout the day and you can use stops and limit orders. They are much easier, more user-friendly products."

As of May 31, there were 233 ETFs in the U.S. with assets totaling $337 billion, according to State Street research. Meanwhile, 1,141 sector funds had net assets of more than $209.9 billion as of May 31. But as a whole, mutual fund assets still dwarf ETFs, totaling more than $4 trillion.

ETF Advantages

It's still early on in the battle between sector-specific ETFs and mutual funds, but there is plenty of evidence that ETFs are gaining fans. The market has been bombarded with an avalanche of choices, which Frankle attributes to strong demand.

These new products look good to investors who want more transparency than they would find with the typical mutual fund, says Lipper senior research analyst Jeff Tjornehoj.

"You know exactly what's in an ETF, and you can decide for yourself if you like the portfolio. With select funds, the portfolio composition can change, and you won't necessarily know that has happened when you're about to buy the fund," says Tjornehoj.