ETFs are ruling

Exchange traded funds have become the dominant investment vehicle. Joshua Lipton of Forbes.com wrote the following story:

Despite last year's market crash, there were 160 new exchange-traded funds launched vs. the introduction of just 21 new mutual funds. At the same time, in 2008, net inflows into U.S. equity exchange-traded funds were a positive $120.8 billion vs. $162.4 billion net outflow for U.S. equity mutual funds.

ETFs keep gaining market share at the expense of mutual funds. Since their introduction in 1993, ETFs have exploded in popularity. As of early 2009, there are now 737 ETFs offering diverse investment strategies, everything from shorting gold to going long on Malaysia. Already "actively" managed ETFs have made their way onto the scene. From 2005 through 2008, ETF assets rose 77% while non-ETF mutual fund assets climbed 9%. ETFs now account for a whopping 40% of all index fund market share. By some estimates, worldwide ETF assets, now at $725 billion, should eclipse $1 trillion within two years.

It seems ETFs are taking Jack Bogle's index mutual fund religion to the extreme. Until recently, fund companies argued that ETFs were merely tools for hedge funds and other institutions. However, ETFs with their liquidity, transparency and cost efficiency are making their way to frontline investors. In fact, among a recent survey of Registered Investment Advisors by Charles Schwab, a full 79% say they now look to ETFs as their top investment vehicles for their clients.

The question for firms that rely on assets in actively managed mutual fund firms is how to compete and regain their luster during this attack of the ETFs.

The first line of counter attack will employ the "if you can't beat em, join em" approach. Expect more mutual fund shops to offer ETFs themselves to investors. Already, of course, companies like Vanguard are very actively involved in dishing up a wide array of ETF products. Vanguard, which launched its first ETF in May 2001, now has $45 billion in ETF assets. And it's continuing to roll out new products: Its 39th ETF--the Vanguard FTSE All-World ex-U.S. Small-Cap ETF--begins trading in early April. Fidelity introduced its first ETF, the Fidelity Nasdaq Composite Index Tracking Stock Fund, in 2003. It's also on a short list of potential acquirers of Barclay's massive iShares.