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Narrow Audience Called Fund Hurdle

new york - Despite their growing popularity, exchange traded funds face substantial obstacles to continued growth, according to industry executives. Foremost among those obstacles are the heavy concentration of assets in a few products and the narrowness of their appeal, the lack of understanding of the products, the need for education and the high cost of entry into the market, according to executives who spoke at a conference on closed-end funds here last week sponsored by IBC USA Conferences of Westborough, Mass.

There have been four years of rapid growth of over 100 percent leading to 79 exchange-traded products with assets of over $56 billion, said Deborah Fuhr, vice president and global head of marketing for Opals and exchange-traded funds for Morgan Stanley & Co. International of London.

While this demonstrates the strength of exchange-traded funds, it is important to examine how that growth has been achieved, other executives said.

"If you read the press out there and you listen to exchange-traded fund proponents in the marketplace, everybody tells you about the exchange-traded funds boom, basically about dramatic asset growth, dramatic volume," said Erik Liik, senior vice president and exchange-traded funds specialist at Funds Distributor of Boston. "They are growing fast, but it's extremely concentrated."

The SPDR 500 (nicknamed Spider' and standing for Standard & Poor's Depositary Receipts), the first exchange-traded fund introduced by State Street Global Advisors of Boston in 1993, is the largest exchange traded fund in terms of assets with over $24.7 billion, according to Wiesenberger, Thomson Financial of Rockville, Md. The Nasdaq 100 Trust Series I, offered by the Bank of New York, ranks second with over $18.2 billion, according to Wiesenberger. Those two exchange-traded funds represent over 75 percent of all assets in exchange-traded funds and this means the prospects for other exchange-traded funds are not necessarily good, said Liik.

Another challenge that faces exchange-traded funds stems from the fact that currently, they are largely attracting institutional investors. Seventy percent of the assets in top exchange-traded funds are institutional assets, according to Liik.

"It's fine that the majority of the assets in these products are currently institutional assets now," said Bill Chambers, president of Wiesenberger. "But to really take that next step, these products are going to need to be adopted by financial professionals as well as individual investors."

To achieve this, intermediaries and consumers will have to be educated about the products, executives said. Exchange-traded funds are complex so their introduction to new planners and investors must be accompanied by education, they said.

"There is a great lack of understanding both by brokers...and investors," said Liik. "Success comes down to education. Education is important, but expensive, and most exchange-traded fund sponsors that are in the marketplace right now do not have the budget."

"Training is going to be extremely important for these products going forward," said Chambers. "Financial professionals do not want to sell products that they don't understand."

The education has to be provided by wholesalers and through more Wall Street research coverage, according to Liik.

"Investors need direction," he said. "Wall Street has to increase coverage in order for these products to be utilized by brokers and investors."

This need for education about the products puts a greater importance on marketing, which in turn helps to create an extremely high cost of entry for these products into the market, said Liik. Another cost of entry is that the introduction of an exchange-traded product can be more complex and take more time than is expected. The Vanguard Group of Malvern, Pa., for instance, is currently in the process of seeking exemptive relief from the SEC in its efforts to introduce a new exchange traded share class. (See related story, pg. 1)

Despite the challenges they face, exchange-traded funds are not merely a fad and will continue to grow, speakers said.