New twist in the index fund-vs.-ETF battle

September 05, 2010|Mark Jewell, Associated Press

Fund investors who want to put their money to work as cheaply as possible have a couple of basic options: They can go with an index mutual fund or a comparable exchange-traded fund.

It’s an either-or proposition. There are index funds and ETFs that invest in the same segments of the market. Whether they hold stocks or bonds, the key distinctions are expenses and restrictions on how investors can get in and out.

Now, however, the nation’s largest fund company is venturing onto a third path, one that’s likely to become well traveled in coming years.

Vanguard plans to launch 19 new funds this month that will be the first of their kind in the industry. Like most broker-sold mutual funds, they will be offered in different share classes, differentiating how an investor pays the sales fee for a fund. But with Vanguard’s new funds, the share class will designate whether someone is investing in a mutual fund or an ETF that holds the same underlying investments.

Perhaps more important for investors, Vanguard is also launching an ETF version of Vanguard 500 Index, an $87 billion behemoth tracking the Standard & Poor’s 500. It’s another milestone for a 34-year-old fund that became the first index fund available to individual investors.

The novel mutual fund-ETF hybrid structure grew out of a patent Vanguard secured before it sought regulators’ permission in June to introduce the soon-to-be-launched products.

It creates a new wrinkle in the traditional index fund-vs.-ETF competition. Some investors might choose to keep some cash in an index fund, and another chunk in the same fund’s ETF class, rather than one or the other.

“Vanguard is very smart to create an ‘and’ solution, rather than an ‘either/or’ solution,’’ said John Osbon, who manages about $45 million at Boston-based Osbon Capital Management.

Mutual funds are priced once a day. This means that when an investor sells, the value is determined by the fund’s price at the close of the market. ETFs are priced throughout the trading day and are traded like stocks. That makes it possible to lock in a preferred price without waiting for a closing price, unlike with mutual funds.

Although both are typically cheap, many ETFs now undercut comparable index funds on costs. And ETFs have consistently drawn more cash in recent years than traditional mutual funds. Still, mutual funds hold more than 10 times as much as ETFs.

“I think the trend has legs, and investors are wise to weigh whether an ETF is the better bet for them versus a comparable index fund,’’ says Christine Benz, personal finance director at fund tracker Morningstar.