From the February 2008 issue of Investment Advisor • Subscribe!

ETF Market's In Good Shape

If mutual funds are the professional football teams of the investing universe--strength in numbers, with the pooled cash following the portfolio-building plays called by quarterback managers--then exchange traded funds could be the offensive linemen. After all, ETFs are efficient, predictable performers; they're not flashy; they stick to their declared knitting; they're much cheaper than those high-priced superstar investment vehicles; and for advisors and, increasingly for institutions, they're the backbone of a prudent asset allocation strategy.

That's just one of the messages that Dan Dolan of Select Sector SPDRs is delivering these days (minus the football analogy). Recalling that the nine sector SPDRs were created to "customize the large cap portion" of an investor's portfolio, Dolan points to the numbers to show the liquidity and cost-sensitivity of those nine ETFs: average daily trading rose to 90 million shares of Sector SPDRs in 2007, he notes, the cost has come down to 23 basis points, and total assets reached $26 billion in 2007, nearly doubling in two short years from the $13.2 billion in 2005 assets. Moreover, Dolan argues that "Good ETFs tend to have a good mix of retail and institutional investors." That's certainly the case at Select Sector, where he estimates that growth has come 70% from institutions and 30% from retail accounts. Hedge funds are buying ETFs, but also plenty of low-cost ETFs are being sold through advisors "at Merrill and other fee-based accounts." Those investors may have different goals in mind--on the institutional side, "the name of the game is to minimize single-stock risk," so "a basket of stocks could be the answer," Dolan suggests. For hedge funds, too, can efficiently short a sector of the overall market using ETFs. That's why, he says, there were 115 million shares of short interest as of December 31, 2007 in the financial Sector SPDR (XLF), compared to 22 million at year-end 2006.

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