While at a neighbor’s house earlier this month for a summer barbeque, I enjoyed an added perk besides the amazing smoked brisket—checking out the two Fords parked side by side in his driveway. One was a fully electric Mustang, and next to it was Ford’s newest gas-guzzling Bronco. Since I’ve owned an electric car for seven years now, I was curious how much he enjoyed the Mustang (short answer: a lot). We then chatted about the auto industry, wondering if this fully electric Mustang might cannibalize sales of Ford’s popular internal combustion engine sports cars.
Market cannibalization. The first time I even thought about that term was in the late 80s when the British pop rock band Fine Young Cannibals cornered the radio airwaves market with their hit “She Drives Me Crazy.” Good luck getting that song out of your head! Now, this term seems to pop up all the time in discussions about the mutual fund industry whenever active managers also have an exchange-traded fund lineup.
In June, Franklin Templeton launched an exchange-traded fund (ETF) run by the same team that manages the firm’s largest mutual fund. In preparation for potential investor questions, I was ready to discuss how this differentiated offering can fit nicely within client portfolios as well as how a multi-asset strategy can deliver income across all market cycles. Heck, I was even ready to have a broader discussion regarding the popularity of active ETFs this year (25% of year-to-date flows through June 20, 20231) and the general benefits of the ETF wrapper. Nope. The first question was: “Isn’t this ETF going to cannibalize your existing mutual funds?” So today, let’s discuss the misconceptions surrounding cannibalization.
In my nearly 100 posts over the past several years, I’ve covered the merits of ETFs using analogies ranging from mattress shopping to quantum physics to baseball batting averages. Over that time, ETF growth has been astonishing. Currently, there are more than 3,000 ETFs with over US$7 trillion in assets in the United States.2 So, it’s hard to argue against investor interest in ETFs.
Of course, there are plenty of investors who prefer other fund vehicles as well. Separately managed accounts (SMAs) continue to gain traction with advisors. Even the traditional mutual fund has alternated between inflows and outflows over the past five years. There’s no doubt that some investors may hold a strong preference for one vehicle while other investors may prefer to use all three, depending on the exposure and type of account.
Cannibalization implies that we hold a pessimism over mutual funds and were therefore motivated to offer an ETF as a substitute. That is not the case here at all. In this case, investors like the investment philosophy of our team but prefer to also have an option in the form of an ETF. This is not cannibalization. It is merely providing different vehicle choices.
Going back to the conversation with my neighbor, I would imagine Ford’s thinking was quite similar. My wife likes her hybrid car and is in no hurry to replace it. She also likes having gas options for longer road trips. For me, I really wanted an electric car due to 1) the cost of gas for my 100+ mile daily commute and 2) access to the California high-occupancy vehicle (HOV/carpool) lanes. The question for Ford was whether they wanted to have options for both of us, and their answer is obviously “yes.”
While we may not all agree on which type of car—or investment—best suits our individual needs and goals, I think we can all agree that it’s good to have options!
WHAT ARE THE RISKS?
All investments involve risks, including possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested. Generally, those offering potential for higher returns are accompanied by a higher degree of risk.
For actively managed ETFs, there is no guarantee that the manager’s investment decisions will produce the desired results.
ETFs trade like stocks, fluctuate in market value and may trade above or below the ETF’s net asset value. Brokerage commissions and ETF expenses will reduce returns. ETF shares may be bought or sold throughout the day at their market price on the exchange on which they are listed. However, there can be no guarantee that an active trading market for ETF shares will be developed or maintained or that their listing will continue or remain unchanged. While the shares of ETFs are tradable on secondary markets, they may not readily trade in all market conditions and may trade at significant discounts in periods of market stress.
Commissions, management fees, brokerage fees and expenses may be associated with investments in ETFs. Please read the prospectus and ETF facts before investing. ETFs are not guaranteed, their values change frequently, and past performance may not be repeated.
Any companies and/or case studies referenced herein are used solely for illustrative purposes; any investment may or may not be currently held by any portfolio advised by Franklin Templeton. The information provided is not a recommendation or individual investment advice for any particular security, strategy, or investment product and is not an indication of the trading intent of any Franklin Templeton managed portfolio.
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1. Source: Bloomberg.
2. Source: Bloomberg, as of June 20, 2023.