ETF growth slows, but bright future still forecast

By Erin Kutz - Analysis

BOSTON (Reuters) - Exchange-traded funds have captured cash at a slower pace this year as the recession has limited investors' nerve and resources, but industry analysts expect the securities' rapid growth to soon resume.

ETFs, portfolios that resemble individual stocks and are traded on exchanges, have been the investment industry's red-hot asset class since being introduced in 1993.

As a group, U.S. ETFs invest $597 billion, a tiny amount compared to the $9.3 trillion managed in non-ETF mutual funds. But demand for ETFs, offered by mutual fund giant Vanguard and some of its rivals, is clearly growing.

So far this year investors have added $35 billion in new cash to ETFs, according to Simfund MF, a fund-tracking database produced by Strategic Insight, while $49 billion has been withdrawn from mutual funds.

In 2008, when markets tumbled during the height of the financial crisis, investors still added $176 billion to exchange-traded funds.

Some industry analysts are skeptical that these portfolios will rival traditional mutual funds and point to the slowdown in demand this year. Other experts expect growth to resume once the economy improves and gives individuals more money to invest, and if stable markets calm nervous investors.

"If we do see better capital markets, we believe that the growth to the structure itself is in its very early innings," said Fran Kinniry, principal of Investment Strategy Group at Vanguard Group Inc, which has about $60 billion in 39 ETFs.

ETFs are especially attractive for investors who want the benefits of owning stocks without the risks.

Loren Fox, senior research analyst at Strategic Insight, said ETFs haven't grown at the expense of traditional funds, but rather have taken in money that previously would have been invested in individual stocks. "The move from single stocks to ETFs is much more pronounced than the move from mutual funds to ETFs," he said.

DIVERSITY, ACCESSIBILITY

Exchange-traded funds give investors access to baskets of stocks, usually in a particular sector and often at lower prices that traditional actively-managed funds.

Providers also tout them as a diversified alternative to direct shareholding: Those interested in a certain company can invest in an ETF in that stock's sector, with the other securities in the fund offsetting the risk that a particular company will fall in value, Kinniry said.

"I may think banks are undervalued and want to invest in them, but I don't know which one has a bomb in the car and which one is a goldmine," said Scott Burns, director of ETF analysis for Chicago firm Morningstar Inc.

Specialized ETFs have gained the greatest percentage of investor dollars this year, with gold-focused ETFs taking the top spot at more than $13 billion in inflows, according to Strategic Insight. The funds provide a simple way to invest in the precious metal, which traditionally does well during economic crises as a protection against inflation, Fox said.

Natural resources and government bond ETFs rank second and third, respectively, behind gold ETFs so far this year, each nearing $8.8 billion in inflows.