Mutual funds are facing extinction

Getty Images

In this handout provided by Destination New South Wales, a Tyrannosaurus rex takes a morning stroll with commuters in Hyde Park on August 28, 2013 in Sydney, Australia

Passive investing is taking over the money management world.

Exchange-traded funds, which simply track an index, have hoovered up assets at a rate over the past decade. The combined assets of ETFs in the US hitting $2.2 trillion in April, according to the Investment Company Institute.

The funds, which are low cost, tax efficient and offer liquidity and transparency, pose an existential threat to the mutual funds industry. Actively-managed (meaning run by a portfolio manager) mutual funds charge higher fees and have struggled for performance of late.

"ETF share in the US is 15% today, but we think it could eventually reach 40-60% over the next ten years," Credit Suisse analysts led by Craig Siegenthaler said in a note last week.

That is bad news for mutual fund companies, which stand to see their revenues decline as assets migrate from more expensive actively-managed funds towards cheaper, passive ETFs.

"So the question on every CEO's mind is - how can active traditional, benchmark-relative managers fight back?"

The answer, according to Credit Suisse, is to evolve.

Siegenthaler and his team highlighted a new kind of ETF structure that could give active managers a chance in their battle against the likes of iShares and Vanguard, which are giants of the passive investing world.

The structure, which is called a non-transparent ETF, or NTETF, is being proposed by Precidian, which is partially owned by fund manager Legg Mason.

"We think the early adopters of Precidian's NTETF could have a head-start in protecting their business from passives and new regulations, and also be successful in winning clients from competitors that only exist in the older mutual fund structures," Credit Suisse said.

The NTETF will function like an existing ETF, and investors will be able to buy and sell them through their existing accounts at traditional brokerage firms and financial supermarkets.

The difference is that, as the name suggests, the NTETF is non-transparent. Like a mutual fund, the NTETF will only disclose its holdings on a quarterly basis, and the redemption process will be carried out through a "confidential" account.

NYSE refiled its application to permit the trading of 15 Precidian NTETFs late last month with the SEC's trading and markets division, so we'll likely find out if they've been permitted by September or October, according to Credit Suisse.

The investment world will be watching.