2005 Turns Out to be the Year of the ETF

Index and exchange-traded funds held special lure for investors during the final years of the bull market for their broad exposure to the stock market. Then, when the bear market hit, they became popular for their low costs. This year, added benefits of ETFs seems to be their tax efficiency and protection from trading abuses, CBSMarketWatch reports.

In years past, the primary investors in ETFs were hedge funds, institutions and traders Today, much of the $210 billion invested in ETFs is from individual investors.

Of the 150 ETFs on the market, only one, based on a semiconductor index, turned in negative performance. Like many regular mutual funds, the best performers of the year were those concentrating on emerging markets, real estate and energy.

What made ETFs stand out during the year, commented Mike Hunnicutt, a financial adviser with Mullins Wealth Management in Fort Worth, Texas, "wasn't any one specific fund, but, rather, the growth in acceptance and usage of ETFs by financial advisers and individual investors."

Among individual sponsors of ETFs, Barclays certainly saw some of the biggest sales during the year, with net inflows ballooning 20.5% from $12.1 billion in the first 11 months of 2003 to $37 billion this year, according to Financial Research Corp.

Net inflows into ETFs at State Street, meanwhile, were $11 billion during the period, significantly higher than the $2.2 billion in net inflows the firm took into mutual funds. Gus Fleites, managing director of adviser strategies at the firm, attributed much of the growth to educating financial advisers on how ETFs can be used as building blocks in a portfolio. Advisers have heretofore resisted index and passively managed products for fear of being unable to properly justify their services.

Looking ahead to 2005, 401(k) plans are very likely to add exchange-traded funds to their lineup. While it's been bandied about for years, now an actively managed ETF might even become a reality this year, propelling interest in ETFs even farther.

Since international, small-cap and value indexes performed so well in 2004, fund companies are also likely to launch more ETFs based on those indexes in the coming year.