ETFs: Why You Don’t Need Mutual Funds

Were I a mutual fund manager, I would have greeted the arrival of exchange-traded funds with all the enthusiasm of a horse-and-buggy dealer seeing an automobile drive by for the first time.

The ultimate throwdown between ETFs and mutual funds has been going on for some time, and while I haven’t surveyed the performance of every single ETF vs. its mutual fund counterpart, I have found two great examples of how the former doesn’t bode well at all for the future of the latter.

I know, I know — you’re buying a manager’s experience when you buy a fund. But what good is that experience if he can’t beat a passive ETF investment? I would say it isn’t any good at all. And worse, it probably costs more.

There’s also a convenience factor. I find it more difficult to trade mutual funds through most brokerages. Investing directly through the mutual fund company wasn’t very attractive, because it would add on fees if I traded the fund too much, and it added more paperwork to my stack every month.

So those are some of the reasons why a few ETFs have become more attractive choices as proxies for some legendary mutual funds.

Do you remember the days when you had to have at least $25,000 to buy your way into the popular Vanguard Health Care Fund (VGHCX). That’s because it outperformed its peers and indices, and — like all Vanguard funds — it had reasonable expenses. Today, the fund only carries an expense ratio of 0.35% and you can get in for three grand.

Its ETF counterpart launched in October 2006. Powershares Dynamic Healthcare (PTH). Although it’s expense ratio is 0.65%, the difference isn’t enough to upset me. More to the point, however, its performance vastly differs. From the ETFs inception date to the present, VGHCX is only up about 16%, while PTH is up about 61%. I’ll take that extra 0.3% expense ratio in exchange for the same downside and much larger upside. And PTH holds plenty of recognizable names: Biogen Idec (BIIB), Amgen (AMGN), Medtronic (MDT), Mylan (MYL) and Eli Lilly (LLY).

One of the most well-known names in the mutual fund world is T. Rowe Price Capital Appreciation (PRWCX). This five-star Morningstar-rated fund has seen an NAV increase of about 20% since December 2006, and carries a 0.7% expense ratio. Meanwhile, PowerShares Buyback Achievers (PKW), considered a large-cap blend ETF, costs the same amount but has seen a 46% increase in the same time frame. There are plenty of great names in here, too, including ConocoPhillips (COP), DIRECTV (DTV), Time Warner (TWX) and Lowe’s (LOW).

If these were exceptions, it wouldn’t be noteworthy. But they’re not, and it is — for just about every good mutual fund idea, there’s an ETF counterpart that’s just as competitive in price, performance or both.

With the exception of 401k investors, who for now still don’t have the option to use ETFs, holding onto mutual funds just makes less and less sense by the day.

As of this writing, Lawrence Meyers did not hold a position in any of the aforementioned securities. He is president of PDL Broker, Inc., which brokers financing, strategic investments and distressed asset purchases between private equity firms and businesses. He also has written two books and blogs about public policy, journalistic integrity, popular culture, and world affairs. Contact him at and follow his tweets @ichabodscranium.

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