The whole point of actively run funds, their proponents say, is that a living, breathing fund manager has a better chance of sussing out great investment opportunities than an exchange-traded fund, which just blindly tracks an index. Indeed, that's one of the reasons actively managed funds have higher fees than ETFs -- to pay for all that expert guidance.
So it might come as a shock to some investors that the top holdings of several major stock mutual funds are actually ETFs. Take the $900 million Columbia Small Cap Core fund (SSCEX). Recently, its largest holding wasn't some hot technology or pharmaceutical stock; it was the iShares Russell ETF (IWM)
The "useful" argument is one that the fund firms also trot out. A spokesperson for Columbia Asset Management uses ETFs as a substitute for cash. When the market plunges, investors often want to sell their fund shares en masse. That can force managers to dump some of their favorite stocks at unfavorable prices to pay off anxious investors. So, fund managers say, they own an ETF, which is easy to sell and lets the fund keep the stocks it really likes. Of course, a fund could just keep cash or short-term bonds to meet the demands of its investors, but fund firms argue that those assets end up being a drag on the fund's returns.
Some experts aren't as generous. ETFs have annual fees, so throwing them into a mutual fund -- which has its own annual fees -- adds additional costs for investors, critics contend. "It's just being lazy. Buy stocks. It's what people are paying you for," says Herb Morgan, president of money-management firm Efficient Market Advisors. Analysts say investors can easily express their own disapproval with the tactic. It's easy enough to look up what any mutual fund holds. If a mutual fund holds a big stake in an ETF, an investor can just buy the same ETF...and sell the fund.