ETFs: Exchange traded funds gaining attention

A few years ago, exchange traded funds (ETFs) hardly made a blip on the investment product's radar screen. ETFs are investment companies and similar to index funds but their shares trade as stocks do on the major exchanges all day long. Now that's all changed: At the end of February, assets in ETFs totaled $80.9 billion or about 10 times what they were five years ago in 1997, according the Investment Company Institute, the trade association for the mutual fund industry.

As for open-end mutual funds, their assets decreased by nearly $51 billion in February. And even though stock funds had an inflow of $4.7 billion that month, money market fund showed an outflow of $5.4 billion.

Along with an increase in assets, the number of ETF investment choices have also multiplied. In 1997, for instance, there were 19 different exchange traded funds around. At the end of 2000, there were 80. Today, Lipper tracks about 100 of them.

Barclays Global Investors are big players in the ETF market offering several dozen different stock ETFs with assets in their iShares brand name now totaling over $22 billion. Inflows into those funds are now averaging between $500 million and $1 billion a month.

Of the ETFs that Lipper, Inc. tracks, it's the iShares that pop-up at both the top and the bottom of the performance list. At the end of the first quarter of 2002, the iShares: MSCI S. Korea fund took top honors--it was up 29.91 percent. In second and third position were the iShares: Mexico Free fund, up 17.07 percent and iShares:Malaysia Free, ahead 13.49 percent year-to-date through March 30.

On the other hand, the three ETFs losing the most during the first quarter were the iShares:GS Network Index, it was down 19.41 percent; the iShares:Dow US Telecom funds, off 16.22 percent; and, streetTracks: MS Internet fund, off 14.08 percent.

Compare the performances of ETFs with stock funds during the first quarter of 2002 and it's ETFs that come out ahead: The average ETF was up 1.82 percent while the average stock fund gained 0.72 percent.

Harold Evensky, a wealth manager in Coral Gables, Fl, has been a big fan of mutual funds for years. Now, however, he's suggesting exchange traded funds to more and more of his clients. "We have a much larger commitment to ETFs today than we did a year ago, " he says. Why? " Because ETFs are very cost efficient, tax efficient and they give us easy diversification very easily."

Evensky says ETFs also serve as a good substitute for core holdings in the large-cap area where, he believes, it has been difficult, if not impossible, for active managers to outperform the market. Regarding their tax efficiency, with mutual funds, the investor is responsible for two kinds of taxes---their individual tax responsibility and the taxes that the funds generate. "ETFs, for the most part," says Evensky, "Are able to avoid that second tax."

While there's a wide spectrum of different exchange traded funds to choose from, many represent specialized sectors of the market, like semiconductors, natural resources or specific countries, and therefore are open to volatile price fluctuations as those markets and sectors go in and out of favor.

They can also be expensive to invest in if your buying a small number of shares frequently. "But, " says Evensky, " If you are investing for a long period of time, they are extremely inexpensive because the cost is only the cost of trading. And that's basically the cost of a sale of stock, which today is very low."

To learn more about exchange traded funds, visit the Investment Company Institutes web site at www.ici.org/facts_figures/etf, or, www.ishares.com.

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Dian Vujovich is a nationally syndicated mutual fund columnist, author of a number of books including Straight Talk About Mutual Funds (McGraw-Hill), and publisher of this web site.