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Dispatches

How ETFs Change Their Fund Families

Mutual funds of companies that also offer exchange-traded funds (ETFs) perform worse than before those ETF products were launched.

by Matthew Bajkowski | June 2020

 

Mutual funds of companies that also offer exchange-traded funds (ETFs) perform worse than before those ETF products were launched. A study found underperformance to be 1.3% per year, based on risk-adjusted returns attributable to the portfolio manager. The study concluded that the brand awareness and cash inflows brought by ETFs reduced the relationship between performance and flows of investor dollars into related mutual funds. Stronger brands shielded mutual funds from underperformance.

While investors value both the brand name and the uniqueness of mutual funds, they seem to value brand name more and are willing to sacrifice fund return for it. This is why having a brand name was worthwhile for the fund company despite strongly and negatively affecting fund performance. Further, the study found that issuing ETFs enhanced a company’s brand and increased advertising.

Mutual funds in families issuing ETFs saw increased inflow and assets under management (AUM), resulting in higher revenue in spite of fund underperformance. These mutual funds also had higher expense ratios, showing that brand name allows funds to charge higher fees even though they are experiencing decreased performance.

The study noted that mutual funds have faced intensified competition from ETFs in recent decades at an expense of actively managed funds. Companies behind conventional mutual fund families are increasingly issuing ETFs to benefit from their popularity. More than half of ETF issuers are mutual fund families, which manage over 90% of ETF assets.

The authors noted that the mutual funds’ underperformance may also suggest that investors’ expectations about the underlying quality of the mutual funds tied to ETFs are not met by fundamentals.

Source: “What Happens After a Fund Family Begins to Offer ETFs?” by Hui-Chieh Chen, Sheng-Syan Chen, Chuan-Yang Hwang and Chin-Te Yu; SSRN, March 2020.

Discussion

Carl Altenburg from NJ posted over 6 years ago:

Brand is very important, after all trust is an important issue, but how was it determined that the underperforming funds would not have grown if their fund families did not offer ETFs? Could it be that the growth of those funds was that they are being offered within limited choice contributory retirement plans? Adding to that is auto pilot investing, such as regular contributions to fixed allocations in individual retirement accounts and deferred annuity plans. There may be something more than brand name and the offering of ETFs that seem to be suspending rational choice.


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