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Why ETFs represent the next generation of mutual funds


By Christopher J. Day, Founder, Days Global Advisors

For the longest time, mutual funds were one of the dominant investment vehicles in the financial industry. Institutional investors loved them. Retail investors loved them, too. They were the go-to vehicle for those who needed to diversify their investment, and they were professionally managed, highly liquid, and reasonably affordable, which only benefited their popularity.

Over time, and certainly in the last couple of years, that popularity has faded. Other, more nimble financial products have taken center stage in the industry, offering some of the positive traits of mutual funds and enhancing them with new and improved characteristics.

Exchange-traded funds (ETFs) are an investment vehicle and a strong contender for the title of the next generation of mutual funds. First developed in the last decade of the 20th century, ETFs started gaining ground following the 2008 financial crisis. The tempo picked up significantly in the second half of the 2010s — with the total AUM of ETFs tripling between 2016 and 2021 to reach $10 trillion, as reported by EPFR.

ETF popularity has grown

There are a couple of crucial reasons why ETFs’ popularity has grown while mutual funds’ popularity has shrunk. One of the key ones is the increased transparency investors have with ETFs. While mutual funds disclose their portfolios on a monthly or quarterly basis, the vast majority of ETFs do it daily.

This kind of transparency benefits the investor in several ways. For example, knowing exactly where their money is invested allows investors to monitor the industries they are exposed to through their investment and make quick decisions based on the information they can gather.

The frequency of disclosures also prevents some unsavory practices from occurring with ETFs. Mutual funds might engage in window dressing, a method of adjusting their portfolio just before they disclose it to look better than it is. That’s much harder to do when the portfolio is announced every day.

ETFs are traded in real-time

Another pivotal advantage of ETFs comes from the way they are traded. With mutual funds, traders buy or sell at a single price point calculated at the end of each day based on the fund’s Net Asset Value (NAV). There’s no trading in real-time with mutual funds.

ETFs are traded in real-time, much like stocks are. An investor can hear some news about an industry they know the fund is exposed to and decide to change their position momentarily. This liquidity allows long-term traders to feel confident and allows day traders to create strategies around daily price movements and seize opportunities when they see them.

Finally, their unprecedented versatility and variability might make ETFs this generation’s go-to trading vehicle. Thanks to their wide variety, an ETF out there matches anyone’s desired type of exposure. For example, investors who want the broadest possible exposure can invest in ETFs that mirror major indexes and ride the same waves passively. On the other hand, there are niche ETFs that focus on sectors or industries, which are a perfect choice for investors with specific interests.

Commodity and thematic ETFs

Then, commodity ETFs offer exposure to assets, including gold or oil. Again, versatility allows for the broadest possible diversification while giving ample chance to capitalize on market movements or even hedge against some risks.

The latest development in the world of ETFs is thematic ETFs or funds that focus on a particular theme instead of an industry. Some ETFs might have a sustainability theme, providing the opportunity to invest in green energy, for example, and clean technologies. Others might focus on robotics or AI. Either way, they allow investment into assets or commodities that fit the theme or the narrative.

The list of reasons ETFs are an upgrade of sorts on mutual funds doesn’t end there. ETFs might also be more tax-efficient, with a more investor-friendly fee structure and a lower minimum investment that makes them a more democratic investment vehicle. They are also innovative and capable of following new developments in tech, for example. ETFs are the essence of modern investment as it is today — efficient, dynamic, and adaptable enough to stay in the attention of today’s investors.

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This article does not constitute investment advice. Make sure you do your own research or consult a professional advisor.

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