Morningstar Advisor - August/September 2011 - (Page 7)

Letter From the Editor The Era for ETFs The news in June was dismal for actively managed U.S. mutual funds. According to the Morningstar fund-flow data, $19 billion streamed out of active funds during the month. Meanwhile, investors poured $1 billion into passively managed funds. That $20 billion gap, reports Kevin McDevitt of Morningstar’s Fund Research Group, is the largest since March 2009. “It’s hard not to notice, too,” McDevitt says, “that some of the funds taking the worst lumps are a who’s-who of active management.” Those funds include American Funds Growth Fund of America AGTHX ($2.9 billion June outflow), Fidelity Magellan FMAGX ($1 billion outflow), and Davis NY Venture NYVTX ($780 million)—all of which saw their worst monthly outflows in years. Investors also pulled another $1 billion out of Fairholme FAIRX, bringing its total outflows over the past four months to $3.5 billion. It’s usually the Cubs who swoon in June. It is not just a one-month blip. For the trailing year through June, active U.S. mutual funds had outflows of $66 billion, while passive funds added $17 billion. American Funds has experienced 24 consecutive months of outflows. Meanwhile, exchange-traded funds continue to gain assets. In June, while mutual funds were bleeding assets, U.S. equity ETFs added $3.3 billion; for the trailing year, they brought in $66.3 billion. A recent study cited by Ignites predicts that ETF assets will double to more than $2.1 trillion in five years. Scott Burns, Morningstar’s director of ETF, closed-end, and alternative fund research, sees numbers such as these as further proof that the future belongs to low-cost, passive strategies and to the most-efficient vehicle to deliver that type of investing—ETFs. “The flows tell the story that asset managers and distribution middlemen themselves don’t want to believe,” Burns says in this issue’s Spotlight article, “Turning Fund Distribution on Its Head” (Page 38). “The times they are a-changing.” Burns argues that the 70-year-old mutual fund structure served its investors well but that it’s time to move on. For one, thanks to technological advancements, the exchanges can provide instantaneous pricing of thousands of ETFs, offering daily liquidity at cheap, flat-rate prices. Mutual fund investors don’t know the price of the shares they purchased until the end of the day. And then there’s the rapid adoption of fee-based and fiduciary advising models. While the mutual fund industry is fighting for 12b-1 fees, more and more advisors are aligning their compensation with the financial success of their clients. These advisors want to “keep costs low, they stay diversified, and they do not churn the portfolio,” Burns says. “They buy the best-performing funds, not the best-paying ... driving the flows into passive and low-cost vehicles at such astounding rates.” With just one tenth of the assets that mutual funds hold, ETFs have a long way to go before they become the investing vehicle of choice for most Americans. And as Don Phillips observes, in terms of costs, tax efficiency, and volatility, each generation of ETFs gets further away from the broad-market pioneers of the 1990s (“You Say You Want a Revolution?” Page 80). But if we are entering a new fee-based, fiduciary age, when efficiency and low costs become paramount, the ETF industry is in a prime spot to offer what advisors and investors will demand. Correction Jerry Kerns Follow Jerry on Twitter @ jerrykerns In the June/July issue, we published the incorrect designation of Elyse Foster, the subject of the Advisor Profile. She is a Certified Financial Planner. MorningstarAdvisor.com 7 http://www.MorningstarAdvisor.com

Table of Contents for the Digital Edition of Morningstar Advisor - August/September 2011

Morningstar Advisor - August/September 2011
Contents
Contributors
Letter From the Editor
Simplicity and Design Matter
Do You Use ETFs Strategically or Tactically?
The Institutional Way
How to Analyze an ETF
Eyeing ETFs’ Next Chapter
Small-Cap/Large-Cap Flip-Flop?
Four Picks for the Present
Investment Briefs
Morningstar Investment Conference
Pitfalls of Peer Groups
A REIT Recovery, With a Catch
Turning Fund Distribution on Its Head
Here Come ETF Managed Portfolios
Circle These Picks Amid the Crop of New ETFs
ETF Analyst Favorites
Beware, the Accidental Portfolio Manager
It’s the Destination, Not the Vehicle
New Growth, Rooted in Experience
Better Ways to Look at ETFs
How to Better Manage Your Clients’ Future(s)
More Bargain Than Bubble
Cheap, Local, and On a Roll
Mutual Fund Analyst Picks
50 Most Popular ETFs
Undervalued Stocks With Wide Moats
First-Quarter Assets Hit an All-Time High
You Say You Want a Revolution?

Morningstar Advisor - August/September 2011