The market share for traditional mutual funds is expected to decline substantially over the next two years, as exchange traded funds and separately managed accounts become increasingly popular.

According to a survey of 1,266 financial advisors by Cogent Research, advisors will reduce their allocation to open-ended mutual funds, which are mutual funds that do not restrict the number of shares they can issue, from 35% of invested assets at the end of last year to 31% by the end of 2009.

Bruce Harrington, managing director at Cogent, said: The use of open-end funds will decline, and well also see a small drop in closed-end funds. Variable annuities are forecasted to remain about flat. The real winners will be ETFs and separately managed accounts.

Harrington added that advisors expect to allocate 60% more assets to ETFs in the next two years. US-listed ETFs now have about $600bn invested in them, and increased by 45% in 2007, according to figures from State Street.

Harrington said: Institutions that historically have offered only mutual funds will have trouble breaking into the ETF space if they are not already there. But he added this may lead to more collaboration and consolidation among mutual fund and ETF managers. In September 2006, for instance, Invesco, a large US mutual fund provider, purchase ETF manager Powershares. And in January Dreyfuss, a subsidiary of BNY Mellon, announced a partnership with WisdomTree Investments to offer fixed income and cash ETFs.

An exchange traded fund is a basket of securities whose holdings and performance closely track those of an index. ETFs can be bought and sold like shares on public stock exchanges. Recently, fund managers have received tentative approval from regulators in the US to start offering active ETFs, which still mostly follow an index but allow the manager to make some active trades within the fund.

Harrington believes this will amplify the shift towards ETFs: The survey showed that advisors really like the features and benefits of ETFs: they offer access to specific areas and theyre easily used in a fee-based platform. Active ETFs will provide all those things investors like about ETFs plus the ability to make investments that can outperform.

Many analysts believe, however, that active ETFs will be less appealing than their traditional version. Active trading could mean higher costs, and the threat of investors front-running, or getting ahead of trades in the fund, means reduced transparency. Tom Lydon, editor of the newsletter ETF Trends, has pointed out that these drawbacks lessen the distinction between ETFs and mutual funds, but in choosing mutual funds investors can at least judge a managers track record. With active ETFs there will be no track record, so it may take a while for them to attract significant interest.

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