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Wednesday, November 30, 2005

Why Are ETFs Outselling Funds?

by: Sean Hanna, Editor in Chief

Exchange-traded funds (ETFs) continue to steal some of the thunder of the open-ended cousins. The latest numbers show that ETFs are outselling regular funds during the stock market bounce that started two months ago.

Dow Jones Newswires suggests in its report on the growing sales disparity between ETFs and funds that retail investors may be more interested in tracking the rising market benchmarks than in purchasing active management. If true, that theory would make sense of the move to ETFs from funds.

One problem with the theory, though, is that the sources of fund flow data do not distinguish between ETF sales to institutional investors (and even other funds) and to retail investors.

The reporter (Jen Ryan) relies on Thomas McManus, a stock analyst at Banc of America Securities, to bolster her thesis that retail investors are behind the shift.

"Retail investors have taken a neutral to negative stance on traditional open-end domestic stock mutual funds, and that has been a boon to ETFs," she writes. She adds that McManus explains the trend by citing "strong demand for popular broad-based indexes like the S&P 500, Russell 2000 and Dow Jones Industrial Average, as well as notable interest in large-cap and growth ETFs."

What cannot be quibbled with is the relatively poor sales numbers for mutual funds during the latest market rebound. During the week ending November 22, for example, domestic equity mutual funds saw net outflows of $530 million compared to net inflows of $3 billion for domestic ETFs.

The four-week moving average sales for domestic equity funds were negative $812 million. Those results cover a period that covers a near 10 percent rise in the Dow Jones Industrials. Meanwhile, ETFs during the same period averaged $2.37 billion of inflows.

Ryan writes that a similar trend is taking place with international ETFs, which pulled in $1.25 million two weeks ago, and international mutual funds, which only sold a net $910 million.

Jumping into the ETF game against Barclays, State Street, Vanguard and Fidelity seems a loserís game for most shops. Therefore, unfortunately, if the trend story is true and retail investors are turning from open-end funds to ETFs, then there is not much the typical fund firm can do but ride out the cycle. 

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