From the June 2017 issue of Investment Advisor • Subscribe!

5 Myths About ETFs and Mutual Funds

To get beyond the chatter, it's good to revisit a few myths about ETFs

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As ETFs have grown in popularity, so has misinformation about them. As ETFs have grown in popularity, so has misinformation about them.

The concept of “fake news” is certainly not foreign to most ETF investors. The ETF industry has experienced exponential growth over the past two decades, and with that progression also comes an influx of self-styled experts. A Twitter handle, blog, website or even a guest appearance on a television show can now provide platforms for such individuals to present their commentary as facts when they realistically are not.

Despite misinformation becoming more prevalent among new media, legitimate ETF experts who have bought, built and sold ETFs still exist and should be relied upon for accurate analysis, even if a little extra work may be required to locate and properly vet them. Separating fact from fiction, the following statements revisit five inaccurate characteristics commonly applied to ETFs.

ETFs are low-cost. On the contrary, ETFs are investment vehicles that can carry low, high or even performance-based fees. Conceptually, it's like assuming a hedge fund or a private fund structure is designed for high fees, when in fact low fees can exist among such funds. The ETF structure, however, can help mitigate costs as previously discussed in this column.

Low trading volume means no liquidity. While this holds true for stocks because their new shares cannot be created or redeemed by a market maker, all investment company ETFs are structured to be open-ended, as an unlimited number of shares can be created or redeemed on a daily basis. As long as the underlying securities in an ETF remain liquid, ETF shares can be purchased or sold at a price very close to NAV, and occasionally even better than NAV.

Remember to use limit orders and to obtain help with trade execution; an advisor can always call the capital markets desk at an ETF sponsor or an ETF liquidity provider, too. In fact, unlike stocks, liquidity gets better with bigger-sized ETF trades.

A transparent ETF can't deliver alpha. A number of strategic (or “smart beta”) ETF providers are “out-indexing” their traditional index counterparts. Discretionary active management also exists among both bond and equity ETF strategies, with many outperforming their index benchmarks.

If large mutual fund managers indicate that they cannot be transparent with actively managed ETFs, remember that transparency remains a likely component in their separately managed accounts, typically to some of the largest institutional investors. All the while, no industry research has ever surfaced that validates alpha would disappear in a transparent ETF.

ETFs cause flash crashes. Algorithmic trading can move at exponential speeds, and a few ETFs have overtaken the largest individual securities in terms of trading volume. However, at $2 trillion in total net assets, ETFs remain the tail on the dog.

ETFs represent a speck in a universe of trading intertwined among futures, bonds, closed-end funds, hedge funds and that other investment vehicle with $17 trillion in assets — mutual funds. Sometimes exchanges and market making can break, and if ETFs did not exist, they would still break from time to time.

Mutual funds will be gone in 10 years. As an ETF sponsor, I can get behind this notion! Kidding aside, mutual funds will not be gone in 10 years. While mutual funds can possess a few advantages over ETFs, their overall market share will inevitably become smaller, but it won't vanish into the sunset either.

While fake news has evolved into the term du jour, no industry stands immune from misinformation, whether inadvertent or intentional. In today's new media world where so many people have access to an electronic megaphone, separating truth from fiction can present a challenge. Even within the ETF space, identify experts that you trust, ask questions and make sure to continue to educate yourself to provide the best opportunity for a successful investment experience for both you and your clients.

--- Read One More Reason ETFs Are All About the Fees on ThinkAdvisor.

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