ETF Outlook: 2010 Will be Hot. Don't Get Burned

Providers of exchange-traded funds and notes had a strong 2009 and the new year is shaping up to bring more of the same. But what's good for ETF companies isn't necessarily good for investors.Not only did these cheap, liquid and tax-advantaged investment vehicles set a new record, reaching more than $750 billion in assets under management as of Nov. 30, according to the National Stock Exchange, but the first actively managed ETFs opened for business.

%%DynaPub-Enhancement class="enhancement contentType-HTML Content fragmentId-1 payloadId-61603 alignment-right size-small"%% All told, exchange-traded products, which include both ETFs and ETNs, enjoyed net inflows of about $90 billion in 2009. What fueled investors' frenzy? An appetite for fixed income, foreign stocks and commodities like gold and oil.

Time To Be Taken Seriously

Meanwhile, industry giants Charles Schwab (SCHW) and Pimco jumped into the ETF fray, while T. Rowe Price (TROW) filed to launch actively-managed ETFs. "This has to validate the significance of ETFs," says Tom Anderson, head of strategy and research for State Street's (STT) ETF division. "It's time to take ETFs seriously."

But how did 2009 change the landscape for ETF investors? Cost competitiveness within the industry became more intense -- and that's a good thing. That's because lower costs can increase performance and give investors more options across various asset classes, says Larry Rosenthal, a certified financial planner with the firm Financial Planning Services. Furthermore, cost pressure could also fuel more mergers among the ETF providers, such as BlackRock's (BLK) purchase of iShares mid-year.

No one expects the appetite for ETFs to wane in 2010, since individuals will continue to invest in low-cost products as higher returns become more difficult to find, says Dan Dolan, director of wealth strategies at Select Sector SPDRS. "International equity and sector [ETFs] will continue to lead [in inflows]," he says.

Not As Simple As They Seem

Furthermore, bond ETFs will likely continue to flourish and there will be more variety. "There will be more bond ETF options as investors begin to use them in a similar way to stocks," says State Street's Anderson. International bond ETFs will increase in popularity as investors choose them for protection against a weak dollar, he adds.

But investors will need to take some of the emotion out of the ETF frenzy, experts says. "If investors continue to pour new dollars into asset classes which have been very hot lately, such as gold, they may get burned," says Jonathan Bergman, vice president at Palisades Hudson Financial Group. "If it is not completely apparent, bubbles burst," he says.

Furthermore, retail investors need to realize that ETFs are not as simple as they seem, says Rob Garcia of Rob Garcia Wealth Management. "As ETFs continue to grow, they also may get more confusing for some investors," Garcia says. "Know what you're buying," he adds, since even very similar ETFs can perform differently.
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