Exchange traded funds opening up

PERSONAL FINANCE

September 25, 2005|By EILEEN AMBROSE

Exchange-traded funds have a fast-growing fan club whose membership includes pension plans, hedge funds and professional investors and traders.

Basically, ETFs are like an index mutual fund that can be traded throughout the day like a stock. You can't do this with mutual funds that are priced once a day when the market closes.

So far, though, ETFs haven't been suitable for small investors who put a little each week or month in the markets. The reason is simple: commissions.

Each time investors buy or sell an ETF, they pay a brokerage commission. And even though commissions have come down over the years, paying $10 or $20 a trade when you're only investing $50, $100 or so a month can erase any advantage of a low-cost ETF.

But things are changing, and the world of exchange-traded funds is opening up to small investors.

One ETF sponsor, for example, plans to launch a direct purchase program that will allow small investors to avoid big commissions.

Other companies are bringing exchange-traded funds to 401(k)s, which is the way millions of workers gain access to the markets by investing small sums from each paycheck.

A large part of ETFs' appeal is they are tax efficient and have low annual fees. For example, the Vanguard Group Inc., the low-cost fund company, charges 0.07 percent for a U.S. equity ETF to 0.3 percent a year for an emerging market ETF.

In comparison, the average U.S. stock mutual fund charges 1.45 percent a year, and an international fund charges 1.73 percent, according to Morningstar Inc.

"In the next five years, we will see a huge surge in the popularity of ETFs among retail investors," said Jeffrey T. Seely, chief executive officer of ShareBuilder Securities Corp., an online brokerage in Bellevue, Wash.

ShareBuilder has been doing its part to bring more affordable access to exchange-traded funds for several years. It allows investors to make automatic investments in exchange-traded funds or stocks on a weekly or monthly basis for $4 per transaction. More frequent traders can sign up for deeper discounts.

The first exchange-traded fund was created a dozen years ago, and tracks the Standard & Poor's 500 index by holding securities that make up that benchmark.

Now you can find ETFs tied to all sorts of stock and bond indexes here and abroad.

Some focus on specific sectors, such as energy, utilities, health care and technology. Gold ETFs were introduced within the past year.

More exchange-traded funds are in the wings awaiting regulatory approval, including one from Rydex Investments in Rockville that would track the price of the euro. And efforts are under way to create the first actively managed ETF, where a professional manager has a hand in adjusting the portfolio.

Today, there are more than 190 exchange-traded funds with assets reaching $260 billion at the end of last month, according to Lipper Inc.

"The growth we have seen is absolutely monstrous," said Tom Roseen, senior research analyst with Lipper.

The second-largest ETF is the Nasdaq-100 Index Tracking Stock, which trades under the QQQQ symbol and has $20 billion in assets.

Nasdaq hopes to launch a direct purchase program of that ETF by the end of the year to cater to the small investor. It would be similar to a dividend reinvestment plan, where investors buy stock directly from a company, usually weekly or monthly, and automatically reinvest the dividends.

The commission would be about $2 a trade, said John L. Jacobs, chief executive of Nasdaq Global Funds in Rockville.

"This would not appeal to someone who buys stocks through a broker," Jacobs said. "It's designed for small amounts. It's for periodic purchases."

Nasdaq would be the first ETF sponsor to create a direct investment program, Jacobs said. "We're all about breaking down hurdles," he said, adding that others would likely follow in Nasdaq's footsteps.

Many small investors gain access to the markets through their 401(k) plans. Workers whose plans offer a self-directed brokerage account have been able to purchase exchange-traded funds.

But outside a brokerage account, ETFs don't easily fit with a 401(k). Again, commissions make ETFs too pricey for small investments that come out of each paycheck. Record keeping has been another hurdle.

Invest n Retire LLC of Portland, Ore., developed a software program to overcome these problems early last year, said Darwin Abrahamson, founder and chief executive officer.

The company now provides exchange-traded funds for a couple of dozen 401(k) plans, he said.

"Our business is starting to explode right now," Abrahamson said.

The company designs a portfolio of up to 10 ETFs for workers based upon a variety of factors, including age and retirement income needs, Abrahamson said. It bundles the trades and makes one a day, spreading the commission over hundreds or even thousands of accounts.

Invest n Retire charges the employer or workers an annual recordkeeping fee of 0.4 percent of invested assets or less, depending on the size of the plan.

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