Why Mutual Funds Should Fear ETFs

By Kevin Grewal, Editorial Director at www.SmartStops.net

The exchange-traded fund world has emerged with full force and continues to put pressure on the mutual fund industry.

ETFs are attractive because they have opened up a new panorama of investment opportunities for all types of investors. They enable investors to grab broad exposure to stock markets of different countries, emerging markets, sectors and styles as well as fixed income and commodity indices with relative ease on a real-time basis. They also cost less than other forms of investing.

ETFs can be traded intraday while enabling investors to remain diversified and have full transparency. They are so versatile that they can be bought on margin, are lendable, and can be bought and sold at market, limit or as stop orders. They don't have any sales loads, and carry expense ratios in the range of 0.05% to 1.60%.

These low expense ratios make it feasible for investors to remain diversified while grabbing exposure to the three major U.S. indices. For example, the PowerShares QQQ(QQQQ Quote) has an expense ratio of 0.2% and grants exposure to the technology-heavy Nasdaq. Investors can grab great exposure to the Dow Jones Industrial Average through the Diamonds Trust Series 1(DIA Quote), which has a low expense ratio of 0.17%. The S&P 500 can be accessed through the SPDRs(SPY Quote), which has an expense ratio of 0.09%.

Another great characteristic is that ETFs have a unique daily creation and redemption process that enables them to keep their market price in line with the underlying Net Asset Value. They can only be redeemed "in-kind," which is beneficial because it doesn't create a taxable event.

Just to get an idea of how the ETF world has emerged, here is a brief landscape of the industry. There are more than 1,677 global ETFs with more than 3,000 listings from 90 providers on 43 exchanges around the globe. Additionally, 109 new ETFs have come to market this year, and plans to launch 756 new ETFs are in the making.

So why should mutual funds feel threatened? A study done by New York-based research and consulting firm Novarica indicates the following predictions for the investment industry: