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ETFs Hang Tough In Bear Market

Exchange-traded funds are no longer the popular products that everyone is talking about. Now, they're just popular products.

Amidst a prolonged market downturn, ETFs are being as widely used as ever. If the media coverage that so engulfed the products last year and through the beginning of this year has quieted, the level of trading volume for the products has not. ETFs have certain advantages over regular mutual funds during times of market volatility, and while their growth rate has been hampered by the downturn, they have maintained investor interest, say industry observers.

ETF assets have been up and down from the beginning of the year. They began the year at $65.59 billion, peaked at $75.56 billion in June, and stood at $72.09 billion at the end of August, according to the Investment Company Institute. Unlike ordinary mutual funds, however, asset movement is not a good indication of investor interest. Looking at trading volume is the best way of determining how popular ETFs are, said Christopher Traulsen, a senior analyst at Morningstar.

In 2001, the combined trading volume for State Street Global Advisors' S&P Depository Receipts (SPDRs) and the Bank of New York's Nasdaq-100 Index Trading Stock (Cubes), far and away the largest ETFs available, have nearly doubled from last year. The average monthly volume grew from 806 million shares per month to 1.6 billion through September, according to Morningstar.

"I would say our belief in the popularity of ETFs last year and the beginning of this year, is continuing if not growing now," said Christine Hudacko, a spokeswoman for Barclays Global Investors, sponsor of the iShares series of ETFs.

Trading volume is not an absolute measure of an ETF's success, however it does say something about the increasing acceptance of the product by investors, said James Ross, a principal at SSgA. "Increased trading volume does not always lead to additional assets, but, in general, it means good things for the products as a whole," Ross said. "It often does lead to additional assets, but it also signifies [that] they are gaining in popularity."

It is not coincidental that the trading volume of ETFs has increased this year during amplified market volatility, said Ross. In fact, trading volume for the SPDRs and Cubes when the market reopened during the week of Sept. 17 was more than 666 million shares, according to Morningstar, and were among the most heavily traded U.S. stocks, in terms of dollar volume according to Ross. By comparison, the highest volume of ETF trading in one month over the past two years was 1.99 billion shares in March. In dollar amounts, the trading volume for the SPDRs for the week of Sept. 17 was $17.6 billion, Ross said. The average weekly amount is $6.8 billion.

There are several reasons why ETFs are more widely used in volatile markets, according to analysts. A major reason is that they can be sold short, said Scott Cooley, a senior analyst at Morningstar. In that way, they are a very good hedging tool, especially for institutional investors to cover positions. Also, in a volatile time, investors are careful to diversify their portfolios, and ETFs provide instant diversification, Ross said.

The lower cost of ETFs relative to mutual funds, largely because of their tax efficiency, is certainly an advantage when investors are uncertain of market conditions. Also, the liquidity of the products is attractive in volatile times because investors can change exposures much more quickly and much more cheaply than with regular mutual funds, Cooley said.

Markets Don't Affect Marketing

Despite the prolonged down market, the marketing efforts of ETFs have gone virtually unchanged, according to Hudacko. "We're still marketing the tax efficiency of ETFs and the importance of that for clients. That's still a message that needs to be communicated, she said. "iShares advertising has never focused on performance so much. We advertise the benefits of iShares, and those benefits resonate much louder in a down market."

This Friday, Barclays will launch four new iShares: the MSCI Pacific Rim Ex-Japan, the S&P TOPIX (Tokyo Stock Price Index) Japan 150, the S&P Latin America 40 Index, and the Goldman Sachs Natural Resources Index, according to Hudacko. Later this year, the firm will launch a series of global sector ETFs, and expects to launch a series of fixed income ETFs either late this year or early next year, depending on the length of the regulatory process, she said.

The buzz on ETFs may have vanished somewhat, but apparently the ETFs themselves have remained visible. "What we've probably seen is that ETFs would have grown at an even higher rate if the market had continued to do well," said Cooley. "The down market has probably reduced the growth rate to some extent, but I think the long-term prospect is very bright for these products."