Sales of exchange-traded funds have grown rapidly in the past three years, but the number of companies manufacturing them in the United States shrank to seven last year and is unlikely to grow, market participants said.

Three of the seven - State Street Global Advisors, Barclays Global Investors and Bank of New York - have nearly 97% of the $228 billion U.S. exchange-traded fund market. There were eight providers in 2003, but UBS Asset Management, which managed two exchange-traded funds in this country, with $116 million of assets, sold out last year to State Street.

"This is a hard product to just jump right into," said Patricia Sanchez-Marin, director of adviser consulting services at the global advisors subsidiary of State Street Corp. in Boston. "You need a licensing agreement with an index provider, you need distribution capabilities, and you need capital to offer these vehicles."

Sales have burgeoned for the leaders. Barclays Global Investors, the San Francisco and London-based unit of Barclays PLC whose iShares exchange-traded funds remain the market leader, expanded its share of the U.S. market to 50.1% last year as its assets under management grew by 97.2%, to $114 billion. Bloomberg News also reported that State Street Global Advisors, which has 33.4% of the market, saw its assets under management grow 32.3%, to $76 billion last year, though its share fell.

Sanchez-Marin said that in the years since the peak of the 1990's bull market, investors have moved assets into exchange-traded funds because the index-linked products offer cost savings and a trading flexibility that typical mutual funds lack.

W. Christopher Maxwell, a managing partner at Conestoga Capital Advisors in Rock Hall, Md., and a former fund executive at both KeyCorp and the former Citicorp, said investors are using exchange-traded funds more often because they can be bought or sold at any time of day and investors do not have to worry about short-term-trading penalties or other compliance issues that have affected mutual funds.

"There are new prohibitions that are affecting mutual funds," Maxwell said. "We are using exchange-traded funds as part of [our] strategy as we transition assets. This is a good place to park assets for a while."

Many other product manufacturers are interested in offering exchange-traded funds, Sanchez-Marin said, but entry is limited because the number of indexes is limited. State Street's exchange-traded funds are linked to the Standard & Poor's and Dow Jones indexes; Barclays' are linked to the Russell indexes; and Vanguard's are linked to the Morgan Stanley Composite Index.

"This is just a market that closed itself up very quickly," said Burton J. Greenwald, president of B.J. Greenwald Associates in Philadelphia. "Everyone wants to offer these products, but most are forced to sell their competitors' products."

Noel C. Archard, the president of Vanguard Vipers, the Valley Forge, Pa., mutual fund company's exchange-traded fund unit, said the "passive approach to portfolio management continues to gather strength and is moving downstream to intermediaries. It is gathering more and more investors."

Vanguard, which started three international exchange-traded funds last week, had $6.7 billion of assets in 23 exchange-traded portfolios at Feb. 28, up from $5.8 billion at Dec. 31. Archard said strong competition from dominant companies like Barclays and State Street forces Vanguard to be creative.

He said Vanguard's ability to offer strong mutual funds in sectors where exchange-traded funds are unavailable gives the fund company an advantage. "We have a great deal of brand recognition on our side," he said. "Investors already recognize us as a great indexer. We are just providing them with another tool. For an intermediary, that is important."

The product has been a little less robust globally than in the United States, according to Bloomberg. In 2004, it reported, the global exchange-traded fund market grew 46% while U.S. sales were up 51%. At Dec. 31 there were 329 ETF portfolios worldwide, with $313.2 billion of assets under management. Of this, the United States has $227.7 billion in 152 portfolios.

Institutional, Intermediary, Individual

Executives agreed that the product has grown quickly because it has gained acceptance among institutional investors, intermediaries and individuals all at once.

Archard said he has seen significant growth through bank sales. He estimated that 60% of investors in his Vipers products are institutional, 30% intermediaries (including banks), and 10% individuals.

Sanchez-Marin agreed that consultants, including those at banks, and advisers have shown a keen interest in exchange-traded funds.

Exchange-traded funds have gained assets, she said, because they are less expensive than typical mutual funds. State Street's SPDRS fund, which tracks the S&P 500, charges only 10 basis points, Archard said.

Vanguard's fees in its exchange-traded funds range from seven basis points to 25 basis points. He said the average U.S. equity mutual fund charges 32 to 33 basis points.

"Lower fees are essential to what we do here," Archard said. "Our fees in our ETFs just went down because the Vipers doubled in size since 2003. That is Vanguard's mandate. We want to bring those economies of scale straight through to the end investor."

Sanchez-Marin said exchange-traded fund providers would need to do more than reduce fees to compete. Companies must start new products to develop market share, she said. State Street started an exchange-traded fund in November that focused on the gold market, she said. In its first three months, StreetTRACKS Gold Shares Trust accumulated $1.2 billion of assets.

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