"I've heard that there are more ETFs in registration now than there are ETFs on the market, and I believe it," says David Cohen, managing director of product development at Claymore Securities in Lisle, Ill. And well he should. ETFs are rolling off the line faster than mutual funds in the 1980s and 1990s. Morgan Stanley recently reported that 354 exchange-traded funds (ETFs) held more than $400 billion in assets. In other words, the number of ETFs have tripled in the past four years, and the assets in those funds have quadrupled (see "On the March," below).

New flavors are coming out all the time. Leading product maker Barclays Global Investors just launched eight fixed-income ETFs. Rival State Street Global Advisors just introduced streetTRACKs Dow Jones Wilshire International Real Estate. Vanguard is filing for four bond ETFs that will be share classes of existing mutual funds. Smaller firms are bringing out leveraged ETFs. As investors pile in, supply is surging.

The panoply of new products seems just as welcome to financial advisors. According to a recent survey conducted with Financial Planning, Rydex Investments in Rockville, Md., found that 64% planners think that the existing ETF lineup provides "a good range of options" or that "more are needed." Only 16% think there are "far too many" ETFs on the market. In a January Financial Planning poll, 58% of advisors named ETFs as the product they plan to use more often in 2007, far ahead of second-place annuities (16%). Expanding the ETF menu, it seems, has whetted planners' appetites.

It's easy to see why. ETFs offer tax-efficiency, transparency, instant execution and lower management costs than most mutual funds. On the tax front, ETF investors don't have to take a capital gains distribution at the end of the year as they would with a mutual fund. They only have tax liability when they sell the ETF.

ETFs are transparent because they are based on established indexes and are essentially passively managed--although some may make regular rules-based changes. So investors know exactly what exposure they're getting. And most ETFs charge 70 basis points or less in management fees. Finally, since ETFs trade on exchanges, positions can be quickly hedged, bought or sold. However, trading commissions can easily overwhelm the cheaper management cost of ETFs.

AND NOW, "SPINDEXES"

Most of these ETFs have been used as cheaper substitutes for index funds, to gain broad market exposure at a cheaper price. Asset manager Rick Ferri, CEO of Portfolio Solutions in Troy, Mich. invests client assets in portfolios composed strictly of ETFs, a strategy more advisors may follow. "The big advantage comes from operational efficiency," he says. "You can trade throughout the day and know what you're buying or selling."

But along with the proliferation of ETFs has come not only finer and more exotic slices of markets, such as Wheaton, Ill.-based PowerShares' clean energy, water, nanotech and currency ETFs, but also a plethora of managed ETFs--or what Ferri calls "spindexes." These ETFs often promise superior returns at lower risk and cost. And they may offer mass affluent clients sophisticated strategies formerly available only through institutional managers.

A few notable entries have posted admirable three-year records. PowerShares' Dynamic Market and Dynamic OTC Portfolios, both started in mid-2003, had annualized returns of 14.60% and 9.55%, respectively, from 2004 through 2006, according to Lipper. That topped the 10.32% and 6.21% annualized returns of the more established SPDR (which tracks the S&P 500) and QQQ (Nasdaq 100) during those years. PowerShares ETFs basically mimic the composition of these indexes, but Powershares ranks stocks by 25 factors and uses the rankings to determine which stocks to select. These are essentially quant funds where stocks are picked and rebalanced within a proprietary rules-based system.

Although some call these newer designer products managed ETFs, they are not truly managed in the sense of an experienced stock-picker using a combination of intuition and experience to buy and sell. It would be very difficult actually to create a managed ETF because it would expose the manager's strategy, says Steve Sachs, director of trading at Rydex Investments. "Managed ETFs are all based on some set of rules, more like enhanced index funds," he explains.

FUNDAMENTALLY SPEAKING

Of all the newfangled ETFs, Powershares' FTSE RAFI US 1000 has attracted the most interest. The fund follows a fundamental, rather than capitalization-weighted, domestic large-cap index, says Bobby Brooks, vice president and national sales manager for PowerShares. "In this ETF, a company's weighting is determined by sales, cash flow, book value and dividends, which provide a truer barometer of its economic impact. Fundamental indexing generates a better benchmark."