Funds of ETFs are the latest craze.
If one is good, two (or five) must be better, right?
With the surging interest in exchange-traded funds (ETFs), it was only a matter of time until someone decided to package them together into a fund-of-funds structure. After all, "funds of funds" are big business, attracting billions of dollars in investments each year. Add in the low-costs and targeted exposure of ETFs, and you should have a hit.
At least, that's the thinking behind a rush of interest in the "funds of ETFs" space. As an ETF reporter, my e-mail box is full to overflowing with pitches from developers of these new products, trumpeting them as smart, "one-stop-shopping" solutions to all the problems vexing today's individual investor. If the developers have anything to say about it, "funds of ETFs" and other ETF portfolio solutions are likely to emerge as one of the major stories of 2007.
But do these products really make sense? Do they provide a service for investors? With the fee structure of some of these fund of ETF products, you've got to wonder if many investors wouldn't be better served to find their portfolio diversification elsewhere, says Jim Wiandt, editor of the Journal of Indexes.
Tom Murphy, owner of TEMAA Financial in Dallas, says his stance on a fund-of-fund solution would depend on whether they retain the chief benefits of ETF investing-low fees and tax efficiency. "If they can get some excess return in the ETF, and remain more tax efficient, then that might be worth" some additional expenses, he says.
Matthew J. Murphy, president of Murphy Capital Advisors in Buckeye, Ariz., is skeptical of paying for someone to package ETFs when he could do the job himself. "All they are really doing is adding an extra layer of fees," says Murphy, which uses ETF products for about 70% of his client portfolio assets.
The Contenders: Mutual Funds
First, it pays to know the field. There are currently two avenues of development in the "funds of ETFs" space.
On the one hand, you have advisory companies and mutual funds that are packaging ETFs into alternative product structures. One example is XTF Advisors, a traditional advisory firm that has decided to focus its energy exclusively on ETFs. The group packages ETFs in a variety of ways-separately managed accounts, open-end funds, unit investment trusts-creating portfolios of ETFs the way you might create a portfolio of individual stocks.
XTF, operating since 2000, has built its business by offering two basic flavors of funds: "Target Maturity" funds designed to fit the needs of investors of different ages, and "Tactical ETF" portfolios that adopt different levels of risk (reflected in different ratios of equity vs. fixed-income exposure). Earlier this year, they also launched sector- and country-rotation portfolios, which use quantitative strategies to move assets to those areas of the market XTF believes are best positioned to outperform.
These products are certainly interesting, because they're offering a sensible, targeted allocation that might not otherwise be available to many investors, and they are doing it at what some consider a reasonable cost.
That's really the rub: how reasonable is the cost? XTF is in the process of launching open-end mutual funds tied to its strategies. For these funds, XTF will layer a 50-basis-point advisory fee on top of the fees charged by the different ETFs. For instance, for its Target Date portfolios, XTF will charge a 50-basis-point advisory fee in addition to the 18 basis points levied by the underlying ETFs. There also will be additional fees of 15 basis points, reflecting trading costs and other charges. In other words, investors will pay nearly 1% per year to hold a group of ETFs that charge just 18 basis points.