The Mutual Fund Rip Off is Finally Ending

Exchange traded funds (ETF’s) could soon replace traditional mutual funds as the primary investment vehicle for individuals because of the huge cost, tax, and liquidity advantages they offer. That’s the opinion of Tom Lydon, publisher of , a snappily designed site that I constantly refer to on all things related to this highly efficient trading instrument.

Tom’s site offers updates on new ETF launches, research tools, and a free newsletter presenting a half dozen investment ideas a day. He finds ETF’s so attractive that he has converted his own management practice for high net worth individuals at from one focused on mutual funds, to an ETF orientation.

ETF’s enable rifle shots at specific countries, industries, currencies, and commodities on the cheap without having to wade through a morass of complicated settlement details. You can buy ETF’s on 50% margin, go short, and with the larger ones, like the S&P 500 (SPY), deal with only a penny spread, plus a token commission.

The ETF industry has exploded since the March bounce, and there are now 836 such instruments issued by 35 providers with a total market capitalization of $782 billion. Recently, the first ETF’s for platinum (PPLT) and palladium (PALL) were launched. Some have grown so large they have become major influences on the market for their underlying commodities. The one for gold (GLD) has $40 billion in assets, making it the world’s fifth largest holder of the yellow metal.

The bigger ETF’s are now resorting to swaps to sidestep CFTC position limits on options and futures contracts. Since most of the current ETF’s mimic indexes, daily buying and selling is minimized, creating fewer taxable events for American investors. Low turnover also helps keep operating expenses down. These quasi index funds confined to narrow groups of stocks can offer better liquidity than any single security. Individual investors can’t put ETF’s into their 401k yet, but that is expected to change soon.

 More controversial are the leveraged ETF’s, like the TBT offering 200% and 300% long and short exposure, which because of their heavy cost of carry, can diverge substantially from their underlying markets. Better to use these only as short term trading vehicles. Other strategies generating debate are funds of funds holding ETF’s with much higher cost structures, and actively managed ETF’s, which cede their index qualities, for better or for worse. Hedge fund ETF’s can’t be far behind.

ETF’s are much more attractive than mutual fund competitors, with their notoriously bloated expenses and spendthrift marketing costs. You can’t miss those glitzy, overproduced, big budget ads on TV for a multitude of mutual fund families. You know, the ones with the senior couple holding hands walking down the beach into the sunset, etc. You are the sucker who is paying for these. Sometimes I confuse them for Viagra commercials.

I once did a comprehensive audit on a mutual fund, and a blacker hole you never saw. There were so many conflicts of interest it would have done Bernie Madoff proud. Any trainee assistant trader can tell you that more than 90% of all mutual fund managers reliably underperform the indexes, some grotesquely so.  Published performance is bogus, as they show a huge survivor bias, not including the hundreds of mutual funds that close each year. And there’s always that surprise tax bill at the end of the year.

If there was ever an industry crying out for restructuring, consolidation, and price competition, and ultimately, a whopping great downsizing, it is the US mutual fund industry. ETF’s may be the accelerant that ignited this epochal sea change, with the number of mutual funds recently having shrunk from 10,000 to 8,000. Still, it’s  early days, with ETF’s only accounting for 5-6% of trading volume, even though they have been around for a decade.

ETF maven Tom Lydon’s favorite ETF’s include the ones for emerging markets (EEM), (VWO) and (EEG), gold (GLD), silver (SLV), and technology (QQQQ) and (XLK). No great surprise that these are the funds seeing the biggest investor cash inflows. They also happen to nicely mesh my own view of the world. 

I wish they had invented these things 40 years ago. It would have made my life so much easier. The potential performance of a Japanese small cap ETF bought in 1969, a gold ETF launched in 1971, or a Chinese technology ETF investment in 1978 would have been positively exponential.

To listen to my complete interview with Tom Lydon, please go to the Hedge Fund Radio page at my website by clicking here at





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