The Growing Popularity of Exchange-traded funds

According to the Investment Company Institute (“ICI”), as of April 2009, there are now 726 Exchange-traded funds (“ETFs”) with over $529 billion in assets.  Since 1995, according to my calculations, the number of ETFs has increased by approximately 96% per year over this period.  Not only has the number and type of ETFs increased but the popularity of these products across institutional investors, financial advisors and individual investors has also risen over this time frame. For evidence of this trend towards ETF utilization, as I referenced in a post earlier this year, one needs to look no further than to Monday, September 15, 2008.  According to Barclays Global Investors, this day represented one of the largest trading days, based on volume, in U.S. history and ETFs accounted for 40% of the trading volume in U.S. equities that day � 40%!
Advisors, in particular, are using ETFs in different ways than they did prior to the historic market declines associated with 2008 and early 2009.  To start, advisors seem to now be looking to the ETF marketplace to gain access to traditional and exotic areas of the market, such as Commodities and Foreign Currencies,  in an arguably more transparent, convenient and cost-efficient means than they could prior to the existence of ETFs or Exchange-traded notes (“ETNs”) for these areas. Additionally, advisors have also been looking to ETF products to provide for enhanced downside protection through short and leveraged short funds similar to those offered by ProShares and Rydex Investments. However, these short ETF products often do not deliver the results that investors would expect for a variety of reasons and generally should not be considered for a long-term portfolio holding.  This last point further underscores the basic need for all investors to complete their own research and understand the pros and cons of any investment before making an investment decision.

With ETFs and ETNs now available, both long and short, for a large majority of the investable universe that many investors look to for their respective portfolio strategies, it is becoming more and more of the norm to see non-active (i.e. traditional index-tracking) ETFs in investment portfolios, just as they are becoming more prevalent, for selected asset classes, in certain Hennion & Walsh managed money portfolios.

Disclaimer: Kevin Mahn is the portfolio manager for SmartGrowth� Mutual Funds, which utilize ETFs as a core part of their investment strategy.

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