Over recent years the ETF industry has experienced rapid growth in the number and variety of ETFs available to investors. A recent report in Reuters highlights that more and more brokers and investment advisors are now offering ETFs as an alternative to hedge funds.

ETFs are already seen as an alternative to mutual funds and for good reason. Just some of the benefits include:

• highly liquid
• broad or narrow exposure
• can be used for hedging
• bought and sold during market hours allowing for automated order execution
• short selling available for many

• can be used sector and style rotation strategies,
• and so on

“There are a lot more ETFs in different asset classes than there had been in the past, and they’re becoming more nuanced,” said Sean Crawford, portfolio manager of the new strategy at Barclays Wealth, which oversees $221 billion (135.4 billion pounds) for clients. “It’s become a pretty compelling investment idea.”

Brokers are using the advantages of ETFs to help move investors from hedge funds. In a hedge fund the investor usually has some lock up period and restrictions on exiting the fund. Plus, they don’t know what their money has been invested in beyond the stated strategy of the fund.

Many investors got “stuck” in hedge funds during the crisis as redemptions were restricted or slowed down and would prefer to have greater control over their investments.

According to Barclays Global. worldwide assets under management (AUM) in ETFs reached a record high of $891 billion by the end of August 2009. There are 1,773 ETFs with 3,137 listings. This compares to 8,000 mutual funds with $10 trillion AUM.

In the US, as of March 2009, there were 694 ETFs with $402.2 billion AUM, plus 139 other exchange traded products (ETPs).

The industry is likely to continue its strong growth trend which will benefit investors up to a point. Offering new ETFs that are essentially the same as existing listings does not really add to investor’s options, it just creates more choices to sort through and potential confusion.

Potential Investment Universe – Risk

When taking volume levels into consideration the number of ETFs as a portfolio option shrinks considerably. More than two-thirds of ETFs listed in the US have volume levels that essentially add short term risk. An ETF trading less than 250,000 average daily volume (ADV) has similar risk to any low volume stock.

An investor can determine a different ADV requirement but still on low volume ETFs volatility is higher, execution risk when entering and exiting a position is increased, and the level of institutional participation needed to propel an ETF higher is missing.