ETFs Eliminate the Dangers of Market Timing

With the mutual fund industry increasingly under attack for suspected illegal trading, advisers say investors have other options, including exchange-traded funds (ETFs). ETFs are baskets of securities that track an index, but can be traded like a stock.

Investors might want to consider this option because, with the list of accused fund firms growing each week, replacing implicated mutual funds with shares in other funds isn't a foolproof strategy. It's not certain which fund might be charged with violations next.

"We think as an alternative to mutual funds, they're very good," Deena B. Katz, a certified financial planner in Coral Gables, Fla., said of ETFs. "In light of this whole mutual fund thing, eventually all of this will shake out and funds will be much better. "But in the short term, it makes people a lot more nervous," she said. "If certain people are going to get out of their funds, they should be invested - they shouldn't go to cash."

ETFs eliminate the danger of market timing, or short-term "in and out" deals, a practice that regulators say is widespread in the fund industry even though fund firms discourage it in their prospectus. Market timing is one of the practices that regulators have been investigating in recent months. Regulators have said market timing and illegal late trading, in which investors are improperly allowed to trade after the close of markets at pre-closing values, costs investors billions of dollars.

Because ETFs trade all day like stocks, there is no "stale pricing" in which mutual funds are priced according to their net asset value once a day. Market timing often exploits the difference between stale prices and real-time stock prices, particularly in overseas markets.

In addition, since ETFs track an index, they have lower fees and more tax efficiency; there is no fund manager making investment decisions and churning the account.

"There can't be any shenanigans," said Tom Roseen, research analyst at Lipper Inc. The investments have boomed in recent years. Currently there are 115 ETFs compared to 30 in 1999. Total assets have grown to $119.7 billion through the end of September, up from $65.6 billion at the end of 2000.