Mutual funds and ETFs have always made for strange bedfellows. While they compete for investor dollars, they may share the same corporate parent. And fund shops that don't offer ETFs are justifiably worried about losing business to exchange-traded investment vehicles. (ETFs are similar to mutual funds in that they hold many stocks, but ETFs trade as a unit throughout the day, whereas mutual funds are priced just once a day, according to their holdings.) ETFs now hold more than $500 billion in assets, including net inflows of $176 billion last year. And according to a recent report by Strategic Insight, ETF assets are on track to top $1 trillion by 2011. "The ETF world is slowly pushing the mutual fund world out of the picture, says Robert Pavlik, chief market strategist for Banyan Partners LLC, an investment advisory firm in Palm Beach Gardens, Fla.

If mutual funds are getting to be a tougher sell, in fact, it's because fund companies are undercutting their own business with similar ETFs. Vanguard, for instance, offers 33 ETFs that are essentially just alternative share classes of their mutual funds. But the ETFs have annual expense ratios that are a fraction the mutual funds , and the differences, while small, can add up over time. Vanguard recently launched a foreign stock ETF the FTSE All-World ex-US Small Cap fund (VSS) with annual expenses of 0.38%, or $38 for every $10,000 invested versus 0.6% for a Vanguard mutual fund that tracks the same index. Sure, the ETF only saves $22 a year, but compounded over time it can add up to thousands of dollars coming out of investors pockets.

The disparity can be particularly glaring in the fixed-income world, where every basis point matters since investors can t count on big capital gains to offset slightly higher fees. Consider: State Street s SPDR Barclays Capital Aggregate Bond ETF (LAG) costs just 13 basis points while the the firm s SSgA Bond Market fund (SSBMX), which is actively managed, costs 50 points. The ETF and fund have the same average credit quality and hold bonds with similar maturities and durations. But the bond fund, which has been around a lot longer, has trailed its benchmark index by 2.6 percentage points a year, on average, over the last decade. The ETF, meanwhile, tracks the same index and would have beaten the bond fund hands-down over the same period, according to performance data from State Street.

Granted, there are plenty of cases where there s no good ETF substitute for the mutual fund, and it may pay to suck up the fees and go with the active manager. The Hussman Strategic Total Return fund (HSTRX), for instance, has gained an average of 7.3% a year over the last five years, handily beating the market thanks to manager John Hussman s flexible style roaming freely among individual stocks, precious metals, foreign currencies and fixed-income securities wherever he sees the most opportunity. Because most ETFs simply track an index, investors have to do their own homework about which sector of the market shows the most promise, and sometimes it s best to leave that to the pros.

ETFs have their drawbacks too, of course. Because they trade like stocks, there s a spread between the bid and ask price, which can cause investors to overpay a bit. And ETFs aren t efficient for building or selling a position over time, as many pros recommend, since trading costs can winnow away their cost advantage. But some pros think investors should probably stick with the ETF, all else being equal. Trying to make a case for a mutual fund, says Pavlik, can be difficult.