Investors Seek Alternative as Fund Probes Continue

Scandals in the mutual fund industry appear to be driving some investors to look for alternatives -- in particular, so-called exchange-traded funds, or ETFs.

ETFs took in a record $14 billion in fresh cash in December, research firm Lipper Inc. estimated Thursday.

That was close to the estimated $15.5 billion net inflow into stock mutual funds last month, Lipper said.

The big ETF inflow suggests investors are getting comfortable with the securities, which offer a simple way to own specific baskets of stocks by tracking popular market indexes, said Don Cassidy, analyst at Denver-based Lipper.

“Investors have taken their time warming up to ETFs, but the [mutual fund] trading scandals have given them an incentive to ramp up their learning curve,” Cassidy said. He estimated that the bulk of the ETF cash inflow in December came at the expense of mutual funds.

ETF assets totaled $156 billion as of Dec. 31, up from $106 billion a year earlier.

Even so, the 11-year-old ETF industry is dwarfed by the $7.2-trillion mutual fund business.

ETFs began to emerge as a rival to mutual funds a few years ago, led by the Nasdaq-100 trust, best known by its American Stock Exchange ticker symbol of QQQ. It tracks the 100 largest non-financial Nasdaq stocks.

ETF fans say the “passive” portfolios carry low management expenses, are tax efficient and allow investors to buy or sell any time during the trading day.

What’s more, ETFs aren’t at risk of the “arbitrage” timing abuses that have rocked the mutual fund industry, because ETF share prices are supposed to match the market values of their underlying stocks at any moment.

A drawback, however, is that ETFs must be bought and sold through brokers who charge commissions, whereas “no-load” mutual funds can be purchased directly with no upfront fees.

Financial services firms including Barclays Global Investors have created ETFs tracking a wide range of market gauges, including broad indexes such as the Russell 2,000 and narrower industry-specific indexes.

The iShares ETFs run by San Francisco-based Barclays took in a record $4.1 billion last month, said spokeswoman Christine Hudacko. This month through Thursday, Barclays’ 84 ETFs took in a net $3.8 billion.

Financial planner Laura Tarbox of Tarbox Equity in Newport Beach, a longtime user of ETFs, said she senses the public has become increasingly enamored of the securities. Since the mutual fund scandal broke in September, Tarbox said she has been barraged with questions about ETFs during meetings with prospective clients.

“If I don’t mention them, people always ask,” she said. “It used to be that nobody really cared.”

But many advisors warn that investors shouldn’t rashly jump from mutual funds into ETFs.

“It’s good that people are being introduced to ETFs, but the fund scandal is a lousy reason to switch,” said Harold Evensky of Evensky, Brown & Katz in Coral Gables, Fla. “Funds are not inherently bad. It’s not like every manager is a crook.”