- The Washington Times - Sunday, January 16, 2005

It wasn’t a bad year for conventional mutual funds, but exchange-traded funds experienced dramatic growth in 2004, raking in an unprecedented amount of new cash.

Interest in ETFs — passive investments that track indexes but can be traded like stocks — has risen steadily since they were introduced more than a decade ago. Equity ETFs closed December with a record-setting full-year inflow of $54.4 billion, according to preliminary data from TrimTabs Investment Research Inc., which tracks fund-flow data for institutional investors.

That far outpaced ETF inflows for 2003, which came to just $15.1 billion, according to the Investment Company Institute (ICI). The previous record was set in 2000, when ETFs collected $42.5 billion.

The ICI, the mutual fund industry’s lobbying group, keeps the official tally of flows, but will not have final figures for 2004 until the end of January. TrimTabs, an independent service that tracks a significant segment of the fund market on a weekly basis, was within 3 percent accuracy of the ICI’s year-to-date totals through November.

For conventional funds, preliminary data showed inflows of $180.3 billion during 2004, TrimTabs said, including an estimated $11.4 billion in December. That was higher than 2003’s inflows of $151.4 billion, but far short of the huge numbers seen in 2000, when conventional equity mutual funds collected $309.4 billion.

All in all, “2004 was not a particularly good year for conventional fund flows,” said Carl Wittnebert, director of research at TrimTabs.

The fact that money flows into conventional mutual funds are substantially below 2000 levels while ETFs have reached a new record suggests the relative popularity of ETFs is on the rise, Mr. Wittnebert said. “Given the tax advantages of ETFs, the only surprise is that it took so long,” he added.

In general, index funds have much lower turnover — meaning they buy and sell stocks less often — than actively managed funds, which lowers the likelihood that they will distribute capital gains. ETFs also charge sharply lower annual expenses compared with most mutual funds, even index funds.

“The number one issue ETFs have over anything else is that these are passive investments, so they are lower cost,” said Darwin K. Abrahamson, chief executive officer of Invest n Retire LLC in Portland, Ore., which provides Web-based services for 401(k) plans and uses ETFs to build portfolios. “The cost of any investment fees you have has a direct relationship to performance, and the lower you can cut the costs down, the higher you’ll raise the investment performance, whether your investment is taxable or tax-free.”

One of the problems small investors have with ETFs is that because they are traded like stocks, each time they buy more shares, they are charged a trading fee. For dollar-cost-averagers — people who contribute to their investment on a regular basis — this has made low-cost index mutual funds a more practical choice. But with many firms working to lower commissions, ETFs’ trading costs are becoming less of an issue, Mr. Abrahamson and other analysts said.

Given their relatively short history, it may come as a surprise that ETFs actually offer more choices for investors who are looking to construct a diversified portfolio using a passive approach.

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