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.

Sector-specific ETFs may also lure investors away from select funds because they do not have short-term redemption fees.

Even a no-load fund charges a redemption fee if buyers sell before a certain number of days or months have passed, and even after that period has expired, it is typically necessary to wait a day before selling.

For example, an investor who buys Fidelity's ( FSAGX) Select Gold Portfolio and then sells it before 30 days are up will face a 75-basis-point redemption fee. On the minimum $2,500 investment, that amounts to an $18.75 fee. On a $10,000 investment, it's a $75 fee.

However, investors who pick up streetTRACKS Gold Shares ( GLD), the largest gold ETF, can buy and sell it like a stock and be in and out of a roundtrip transaction for about $20, says Tjornehoj.

Mutual Funds Not Done

John Sweeney, senior vice president of mutual fund product management at Fidelity Investments, notes that short-term trading fees are an industrywide norm used to protect longer-term investors, which is a value-added plus not offered by ETFs.

Indeed, the relative advantages of ETFs over select mutual funds are not as relevant for investors with a medium- to long-term outlook.

"Select fund investors are probably somewhere between a trader and a long-term investor, so it's not hard for that person to hold onto the fund for the duration of the redemption period," Lipper's Tjornehoj says. "And since there's no commission fee to buy or sell, these are still good for investors in it for at least the medium term."

Sweeney agrees, adding that a select fund brings with it active management for investors who want more exposure to a sector.

And mutual fund analysts such as Morningstar's Sonya Morris worry that these more granular ETF products could hurt investors who are not sophisticated enough to trade them. Morris notes that the ETFs could attract performance chasers, just as in stocks.

Select mutual funds also will continue to dominate their ETF counterparts so long as they have the power of advertising and name recognition on their sides, Tjornehoj says. Being perceived as a dependable product that delivers returns is a huge part of the battle for investors.

"A company like Fidelity won't just do away with select mutual funds, and they won't slip away," says Tjornehoj. "They can advertise and to go advisors and get their products in front of them. ETFs, with their skinny expense ratios, don't have a whole lot of services behind them."

Sweeney also notes that the added value of actively managed funds could justify higher fees. "There's a lot of demand for these select funds, and when it's all said and done, we deliver a lot and are competitively priced."

Frankle, though, maintains his belief that select-fund market share will continue to drop as ETFs attract more investors.

"It's only a matter of time before there are ETFs out there that mirror the performance of select funds, and then it's bye-bye select," says Frankle. "Or mutual funds will get smart and make products that are more like ETFs, meaning they will get rid of the short-term redemption fees.

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