In recent years, exchange-traded funds been giving mutual funds a run for their money. ETFs have many advantages in terms of tax efficiency, diversification and asset allocation. But instead of competing against ETFs, mutual funds are increasingly investing in them. According to fund tracker Mornginstar.com, there are 39 funds that invest at least 80% in ETFs -- baskets of securities that trade on an exchange the way stocks do. More of these products are expected to roll out this year and in the future as awareness of ETFs and their benefits grows. ( HRITX) The Huntington Rotating Markets Fund , geared toward retail investors, has been investing solely in ETFs since it rolled out about five years ago. Paul Koscik, portfolio manager of the fund, says he uses ETFs mainly because of the flexibility they provide. For instance, he says, a large-cap manager is limited to large-cap stocks. If that group goes out of favor, the manager is stuck. A portfolio of ETFs however, he says, lets you rotate into different segments of the market in an easy and cost-effective way. The fund, which has $50 million in assets, rotates between four segments: U.S. large-cap stocks, U.S. mid-cap stocks, U.S. small-cap stocks and global. Currently the fund is in the global segment and has 54% allocated to U.S. stocks.
The Huntington Rotating Markets Fund, which currently invests in 22 ETFs and carries an expense ratio of 1.17%, uses a combination of quantitative and qualitative measures to identify which areas of the market to be in. Jeff Tjornehoj, a senior research analyst with fund tracker Lipper, says those costs are reasonable, particularly compared with those of most active mutual funds, which have an average cost of about 1.5%. And while they are more expensive than just purchasing an ETF (the average ETF fee is somewhere in the 0.40% range), these funds factor in the costs of managers who have some discretion over the fund. AdvisorOne's five mutual funds also invest almost entirely in ETFs. Two of the funds, the $587 million ( CLSAX) AdvisorOne Amerigo and the $130 million ( CLERX ) AdvisorOne Clermont , were launched in 2002 but didn't fully transition into funds of ETFs until 2003. Prior to that, they were funds-of-funds. The rest of the family is made up of the $99 million ( CLBLX) AdvisorOne Berolina , which launched in January 2006, and the $106 million ( CLDEX) AdvisorOne Descartes and the $30 million ( CLHAX) AdvisorOne Liahona , both of which launched in April 2006. Robert Jergovic, one of the portfolio managers of the funds, says being able to use ETFs has been a gift. "When we looked at where performance came from in our strategy, it had less to do with security selection and more to do with asset allocation," he says. "And ETFs were made for that." Jergovic adds that the ETFs also provide lower costs, liquidity and precision, because ETFs are transparent -- you know what you're buying. "It gives you a better perspective of how the pieces of the portfolio fit together," he says, adding that using ETFs also provides scalability to the business, because it is easy to trade large amounts in and out of ETFs, and the transaction costs are minimal.
Another fund also aimed at retail investors is ( FLAGX) Flex-funds Aggressive Growth , which invests about 90% in ETFs of various styles, sectors and market capitalizations on the basis of their relative strength to that of the overall stock market. The fund, which has been around since 2000, has about $21 million in assets. There are also several funds that are structured as target-date funds and are designed for inclusion in 401(k) plans. Target-date funds, which have surged in popularity in recent years, adjust asset allocations from more aggressive to more conservative as the investor approaches retirement. Seligman offers a variety of these funds: ( STJAX) Seligman TargETFund 2015 , which has $31 million in assets, ( STKAX ) Seligman TargETFund 2025 , which has $25 million, and ( SHVAX) Seligman TargETFund Core , which has $60 million. Federated Investors has three target-date funds of ETFs, which it launched in April: ( FTOAX) Federated Target ETF 2015 , which has $1 million in assets, and ( FTWAX) Federated Target ETF 2025 and ( FTHAX) Federated Target ETF 2035 , which have assets of $2 million each. There are also a few companies that have target-date mutual funds of ETFs in registration, including AIM Investments, a unit of Amvescap PLC, and XTF Advisors. AIM has registered six mutual funds that will invest in PowerShares ETFs. XTF Advisors has four target-date mutual funds of ETFs.