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Financial advisors will soon hold more client assets in exchange-traded funds than in mutual funds for the first time, according to a new report from Cerulli Associates.
Nearly all advisors use mutual funds and ETFs, about 94% and 90%, respectively, Cerulli said in the report. Report Published on Friday.
However, advisors estimate that by 2026 a greater share of client assets (25.4%) will be invested in ETFs relative to the share of client assets in mutual funds (24%), according to Cerulli.
If that happens, Cerulli said, ETFs would become “the most heavily allocated product vehicle among wealth managers,” beating out individual stocks and bonds, cash accounts, annuities and other types of investments.
Currently, mutual funds account for 28.7% of client assets, and ETFs account for 21.6%.
ETFs are similar to mutual funds. They are essentially a legal structure that allows investors to spread their assets across a number of different securities, such as stocks and bonds.
But ETFs are increasingly popular with investors and financial advisors because of a few key differences.
ETFs hold about $10 trillion in U.S. assets. While that’s about half of the roughly $20 trillion in mutual funds, ETFs have been steadily chipping away at mutual funds’ market share since their introduction in the early 1990s.
“ETFs have been attractive to investors for a long time,” said Jared Woodard, investment and ETF strategist at BofA Securities. “There are tax benefits, fees are a little lower, and people like the liquidity and transparency.”
lower taxes
ETF investors can usually Avoid certain tax bills that many mutual fund investors incur each year.
Specifically, mutual fund managers generate capital gains within the fund when they buy and sell securities. This tax liability is then passed through to all fund shareholders each year.
However, the ETF structure allows most managers to trade stocks and bonds without creating a taxable event.
By 2023, 4% of ETFs will take capital gains distributions, compared with 65% of mutual funds, said Bryan Armor, director of North American passive strategy research at Morningstar Inc. and editor of the ETFInvestor newsletter.
“If you don’t pay taxes today, then that money is compound interest to investors,” Armor said.
Of course, both ETF and mutual fund investors will need to pay capital gains taxes on their investment profits when they eventually sell their holdings.
Cerulli said liquidity, transparency and low fees are the top reasons advisors choose ETFs over mutual funds.
The average expense ratio for index ETFs is 0.44%, which is half the 0.88% annual fee for index mutual funds, according to Morningstar. Morningstar data shows that the average fee for actively managed ETFs is 0.63%, while the average fee for actively managed mutual funds is 1.02%.
Lower fees and tax efficiency mean lower overall costs for investors, Amor said.
Transactions and Transparency
Investors can also trade ETFs during the day just like stocks. While investors can place mutual fund orders at any time, trades are only executed once each day after the market closes.
ETFs also typically disclose their portfolio holdings on a daily basis, while mutual funds typically disclose their holdings on a quarterly basis. Experts say ETF investors can see the assets they are buying and changes in their portfolios more regularly.
However, experts say ETFs have their limitations.
Additionally, Armor said, unlike mutual funds, ETFs cannot attract new investors. He said this could put investors at a disadvantage in ETFs with concentrated investment strategies. As ETFs attract more investors, fund managers may not be able to execute the strategy well, depending on the fund, he said.
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