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ETF Mutual Funds – Do More Fees Equal Better Performance?

ETF Mutual Funds – Do More Fees Equal Better Performance?

By Simon Maierhofer, Co-Founder
June 16, 2008

 

SAN DIEGO - (ETFguide.com) - Survival of the fittest – what’s true in nature also applies to mutual funds. Competition for new assets is fierce among mutual fund and ETF providers alike.

 

Many mutual fund companies enjoy consistent inflows of new money from 401(k )contributions (Fidelity, American Funds, etc.), a market ETFs have yet to make significant headway. By contrast, retail mutual funds lack the luxury of 401(k) inflows and are loosing assets while ETFs are gaining.

 

>> more details – “Are ETFs Killing Retail Mutual Funds?”

 

To get a slice of the rapidly growing “ETF pie”, mutual fund companies have started to offer ETF-mutual funds. That’s right! You can own ETFs inside a mutual fund wrapper.

 

Before you start celebrating, it's important to understand what you're losing.

 

Not only are the tax-advantages and trading flexibility of owning ETFs completely lost, you also get robbed of low expense ratios as an extra layer of management fees is added to your tab.

 

The benefit of ETF mutual funds, according to the fund industry, is professional management which is supposed to lead to better performance. Right? We know that there is only a very tiny elite group of mutual funds that is able to outperform their corresponding benchmark with some measure of consistency. But what about mutual funds that own ETFs?

 

Advisor One Funds offers a set of five ETF-mutual funds called; Amerigo, Berolina, Clermont, Descartes and Liahona. Amerigo outperformed the S&P 500 by 0.45% during the first quarter of 2008. The S&P 500 seems inappropriate as benchmark however, since the top two fund holdings, the iShares S&P Latin America (Ticker: ILF) and iShares MSCI Emerging Markets (Ticker: EEM) make up almost 20% of the fund's assets.

 

The remaining four funds managed by Advisor One underperformed their respective benchmark on average by 2.44%. The funds have expenses that range from 1.42% to 1.47% with the possibility of front end or deferred sales loads that range from 2% to 6%. Add it all up, and it's a lot of unnecessary fluff.

 

If you don’t quite know how to build your own portfolio of ETFs, check out ETFguide’s Ready-To-Go Portfolios. Six different portfolios with six different investment objectives and enviable performance are what make this service unique. The Strategic Balance Portfolio, a portfolio with a balanced allocation to many different asset classes is up over 2% YTD while the S&P 500 has lost over 7% YTD.

 

Aston Asset Management offers two ETF-mutual funds which where just launched earlier in 2008. The Aston/Smart Allocation ETF Fund holds over 45% of its assets in the iShares Lehman 1-3 year Treasury Bond ETF (Ticker: SHY) and iShares iBoxx Investment Grade Corp. Bond ETF (Ticker: LQD) and still managed to barely break even with the S&P 500 and underperformed their benchmark mix of 35% MSCI World Ex-US Index, 35% Russell 3000 Index and 30% Lehman Bros Aggregate Bond Index.

 

I saved the "best" for last and by "best", I really mean worst.  

 

The Aston/New Century Absolute Return ETF Fund holds almost 8% of its assets in the Oil Service HOLDRS (Ticker: OIH) and the Energy Select Sector SPDR (Ticker: XLE). Energy was one of the best performing industry sectors in 2007, yet Aston still managed to underperform its benchmark, the Russell 3000.

 

The annual management fee (including 12b-1) ranges from 7.53% to 7.83% which is reduced after applying the expense cap to 1.47% to 1.67%. The expense cap is guaranteed for one year only.

 

The iShares Russell 3000 Index Fund (Ticker: IWV) which tracks the same benchmark the Aston/New Century Fund compares itself to, comes equipped with a low expense ratio of  0.20%. The iShares fund also has better tax-treatment, trading flexibility and many more advantages.

 

Who's benefiting more from ETF geared mutual funds? Is it fund shareholders or fund companies?

 

The answer is all too obvious.

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