Exchange-traded funds (ETFs) are definitely gaining wider appeal. But financial service providers, once happy to welcome predominantly institutional investors to these products, are now busily focusing efforts to entice long-term investors.

Barclays Global Investors of San Francisco, which currently sponsors 97 ETFs, estimates that roughly half of the investors in Barclays' iShares-branded ETFs are individual investors with a planned holding period of more than four years, noted Lee Kranefuss, chief executive officer of Barclays' intermediary and exchange-traded fund business.

The use of ETFs in portfolios is definitely seeing "explosive growth" said Paul Hatch, director of managed accounts at Smith Barney of New York, speaking at a recent ETF Summit meeting. Smith Barney's pioneering unified managed account platform, internally referred to as Integrated Investment Services, now includes 137 different separate account options using 250 open-end mutual funds and 50 ETFs that Smith Barney advisers can custom combine for clients. One pre-formulated managed account offering is now made up entirely of various ETFs, Hatch noted.

ETFs now account for about 30% of the separately managed account investment solutions his firm's advisers recommend to clients. Smith Barney's proprietary managed account platform has attracted $2 billion in assets since its introduction to internal financial consultants one year ago, Hatch said.

Smith Barney advisers are using ETFs to reduce risk where a benchmark is used or to control the risks otherwise associated with active management components, he said. ETFs are also being used where smaller allocations of dollars make sense. In addition, in situations where the financial adviser personally serves as the portfolio manager for a client and independently determines appropriate asset allocations, ETFs are increasingly being selected to fill a sector need in lieu of individual securities, Hatch added. Moreover, fixed-income ETFs are also seeing robust use.

ETFs in 401(k)s

ETFs are also increasingly being used within 401(k) plans, said Darwin Abrahamson, chief executive officer of Invest n Retire of Portland, Ore., which offers Internet-based services to 401(k) plan sponsors. When Invest n Retire first began in 1998, it was bundling low-cost index funds for employers in order to minimize plan costs. But the firm has since migrated to even lower-cost ETFs with fees of a mere 30 to 35 basis points, versus the 150 to 200 basis points that the average open-end mutual fund charges, Abrahamson said.

Investment costs account for 80% to 90% of total 401(k) plan costs, which employers typically pass along to participants, he noted. "If you can keep the costs down, [employees] will have more money," he said.

Last year, Invest n Retire began developing the technology necessary to facilitate the use of ETFs within 401(k) plans, and just last month filed for a patent for how the firm envelopes ETFs into 401(k) plans, Abrahamson noted.

Invest n Retire has also found a way around one of the barriers to using ETFs for participants' regular salary deductions, each of which would incur significant brokerage transaction fees. The firm bundles all trades together daily, and then trades through an omnibus account. This cuts the transaction costs per plan participant to just pennies.

How big is the market for ETFs in 401(k)s? "The market is potentially totally unlimited," Abrahamson said. While the majority of assets flowing into 401(k) plans is still being invested in open-end mutual funds, sponsors, especially large sponsors, are asking for other options, and, in particular, ETFs, he said.

Ameritrade Holding Corp. of Omaha, Neb., which up until now had been the favored home of many frequent stock traders, last month unveiled its new online Amerivest program for a whole new audience: long-term, mass affluent investors. The firm has built a five-step system to walk goal-oriented, buy-and-hold investors through the risk assessment, asset allocation and account opening process. Based upon the answers to a series of questions, the firm then recommends appropriate allocations, including ETFs. The new online program even includes an automatic default option that allocates all assets to a menu of Barclays' iShares. This goes far beyond the ETF information center it debuted on its Web site this past January.

Ameritrade plans to advertise the new online program for self-directed investors sometime early next year, said Michael Feigeles, executive vice president of Ameritrade.

The novel feature of the new program is that Ameritrade will not charge investment clients any of the usual brokerage transaction fees associated with buying or selling shares of an ETF. Instead, Ameritrade will absorb all related transaction costs but charge an asset-based fee of 50 basis points for accounts with less than $100,000 and 35 basis points for accounts exceeding $100,000, Feigeles said. Accounts with under $20,000 are subject to the lesser of $100 minimum account fee or 2.95% of assets.

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