By Frederick P. Gabriel Jr.
BOSTON — Exchange-traded funds are so hot, even mutual fund stock pickers can't resist using them.
Approximately 80 U.S. stock mutual funds have more than 5% of their assets invested in ETFs, which are an increasingly fierce competitor to the mutual fund industry, according to Morningstar Inc., a Chicago-based fund tracker. Although there's nothing inherently wrong with investing in ETFs, big investments in the passively managed vehicles certainly raise questions about what the fund manager is doing to earn his or her money.
"It's sort of the equity equivalent of investing in cash," said Roy Weitz, publisher of the Tarzana, Calif., online newsletter FundAlarm.com. "I mean, it's certainly not the kind of active stock picking that you are hiring a manager for."
Consider, for example, New Century Aggressive, a $6.8 million fund of mutual funds run by Weston Financial Group Inc., Wellesley, Mass. On its website, Weston touts that its funds "invest in actively managed portfolios of mutual funds."
But 70.7% of the fund's assets were actually invested in eight ETFs on Aug. 31, according to Morningstar.
The no-load fund, which makes clear in its prospectus that it might invest in mutual funds and ETFs, has an annual expense ratio of 1.5% and has gained an average annualized 15.74% over the three-year-period ended Oct. 18, vs. 16.10% for its peers. It was up 6.40% for the year ended Oct. 19, compared with 2.07% for its peers.
Then there's American Performance Small Cap Equity, run by BOk Investment Advisers Inc., a unit of Bank of Oklahoma NA in Tulsa.
The fund "invests in a broadly diversified portfolio of small-cap stocks exhibiting strong growth and value characteristics that pass through our strict quantitative risk/ return security selection process," according to its prospectus.
But as of June 30, 14.77% of the fund's assets were invested in the iShares Russell 2000 index and the iShares S&P SmallCap 600 index.
The fund has an expense ratio of 0.86% and was up an average annual 17.99% for the three-year period ended Oct. 19, vs. 21.36% for its average peer. It was up 3.82% year-to-date through the period ended Oct. 19, compared with 1.02% for its average peer.
"I'm surprised that an actively managed fund would use an ETF," said Neil J. Hennessy, president and portfolio manager at Novato, Calif.-based Hennessy Advisors Inc. "They are basically setting some of the performance of the fund to an index."