Wall Street's Newest Scam Revealed

The sawed off shotguns are cocked, the ski masks are on, and the get-away car engines are running.  They can feel the adrenaline pumping through their veins, heightening their senses and sharpening their reflexes.

If this sounds like the opening of a Blockbuster Summer Movie, you'd be half right, because the white collar version of this robbery scene is playing out right now in the war rooms of America's biggest Mutual Fund companies.

The Wall Street scam machine is moving into high gear, and it has its eyes set on your money.  Faced with the reality of declining fees -- caused by departing customers who've smartened up and woken up to the fact that 75% of all fund managers cannot beat the S&P 500 -- the Mutual Fund boys have applied their big brains and created a novel way of parting you from your cash.


Customers Got Smarter

This performance gap has caused disgruntled investors to shift their assets away from Mutual Funds and into passive funds called Exchange Traded Funds (ETFs).  They are called passive because they don't need an investment management team calling the stock picks.  Instead, ETFs are set up to mimic the performance of an index like the Dow Jones Industrial Average or the S&P 500.

Since 75% of Mutual Funds cannot beat the S&P 500, many investors have started to sell their Mutual Funds and just buy Index ETFs.  The growth in ETFs has been phenomenal because, unlike a Mutual Fund, the fees are low, ETFs offer pinpoint exposure to a specific index, many trade options, and you can buy and sell (as well as sell short) an ETF just the same way you can trade a stock.


A Dying Business

For the last 30+ years, the biggest fee generating machine on Wall Street has been in setting up and managing Mutual Funds.  More individual investor money is committed to them than any other investment form.  At the last count, 23% of America's investable wealth, $13 trillion, is in Mutual Funds.

Many of these funds charge fees that range from a half a percentage point to well over 1% per year.  That puts the fees generated from this industry into the hundreds of billions of dollars.  But the big Mutual Fund fee party is about to come to a crashing halt.


The Scam Takes Shape

They know that they cannot compete with the passively managed ETF model... they see the writing on the wall:  In 20 years' time their industry will be a shell of its former self. 

Their solution is to take their Mutual Fund managers and put them into their own actively managed ETFs.

So instead of the ETF passively copying an index's performance, the new mutant fund -- oops, I mean Mutual Fund -- ETFs will be actively managed.  You have to ask yourself, if they couldn't beat the S&P 500 when they were Mutual Funds, how in the heck will they beat the S&P 500 as an ETF?

This is where their decades of marketing prowess will come to bear as they attempt to CON…..vince a new generation of investors that they should abandon passive ETFs and embrace "professionally managed" ETFs.


Here Come the Clowns… Sorry, I Meant to say Clones

Possibly the most egregious of these Mutual Fund mutants are the so-called Hedge-Fund Clone funds.  They are truly ridiculous, and I am shocked that two of these funds even made it to market.  Here’s how they work... these funds are designed to mimic the holdings of famous hedge fund managers.

Sounds like a great idea, right?

Remember, all the greatest scams come with a little pizzazz, and what could be sexier than coat-tailing America's smartest money managers? 

But here is the problem:  The fund sponsors are attempting to replicate these holdings by following the 13F filings of the most successful funds.

What's a 13F?

Once a fund gets to a certain size, it must reveal its holdings via a 13F filing.  However, the 13F filed with the SEC is always at least 45 days old!  In some cases a fund can get a special waiver, postponing a 13F filing far further than 45 days.

The other problem is that the hedge fund could be long gone out of that trade before they have to file another 13F letting the SEC know they sold the position!

Can you imagine a more terrible investment approach?

These two "mutant" ETFs are AlphaClone Alternative Alpha ETF (SYM: ALFA) and Global X Top Guru Holdings ETF (SYM: GURU). 

Not all mutant ETFs will be so easy to spot, and you can bet that hundreds more are on the way.  So a good rule of thumb is to avoid any ETF that refers to itself as a "managed" ETF.

Teeka Tiwari
Chief Investment Officer
ETF Master Trader