Sunny Skies for ETFs

Global equity markets recovered in 2003, but the market for exchange-traded funds didn't. You don't have to recover if you never went down in the first place.

As Morgan Stanley analyst Debbie Fuhr details in a report out this week, ETFs had a banner year. Total assets for the equity products climbed to $211 billion in 2003 from $811 million. In fact the number of ETFs worldwide has jumped in the past 10 years to 280 from three. Most importantly, ETFs saw their greatest growth spurt during the market meltdown of 2001 to 2002, and throughout the mutual fund scandal of late 2003.

With such spectacular growth behind them, what's in store for ETFs going forward?

John Jacobs, chief executive of Nasdaq Financial Products Services, believes the ETF boom is in its earliest stages. "First there were equity-index ETFs, and now fixed-income ETFs are getting started in earnest," he says. "In the future, actively managed ETFs will challenge closed-end mutual funds."

As the managing force behind the 1999 introduction of the world's most heavily traded ETF, the Nasdaq 100 Index Tracking Stock(QQQ Quote), Jacobs has the pedigree to prognosticate. Under Jacobs, Nasdaq Financial Products has launched more than 400 products based on Nasdaq indices in more than 25 countries.

Jacobs' faith is based on the length of time it took the QQQ (commonly called the Triple Q) to filter down from a high-end institutional vehicle to a stock commonly found in retail investor portfolios as a cheap, easy index fund substitute. Jacobs anticipates that once retail investors become familiar with other ETFs, the funds will become as ubiquitous as the Triple Qs.

The retail appeal behind equity-index ETFs becomes strikingly clear in the current mutual fund witch-hunt environment. Consider the benefits of ETFs compared with mutual funds:

Diversification: Like an index mutual fund, ETFs provide diversified exposure to an index, industry, sector or group of stocks. However, unlike mutual funds, ETFs do so in a single investment that can often be hedged with options.

Tax advantages: Unlike mutual funds, ETFs have no hidden capital gains -- taxes are owed only on gains actually realized.

Top 10 Here are the 10 ETFs with the heaviest trading volume over the past year
Name	Year-to-Date Return %	Three-Year Return %	Trading Volume
1. NASDAQ 100 Trust Shares	1.73	-13.15	69,757,000
2. SPDRs	1.04	-3.09	27,970,800
3. iShares MSCI Japan Index	2.70	-3.08	11,518,600
4. Semiconductor HOLDRs	3.40	-5.76	9,702,100
5. DIAMONDS Trust, Series 1	0.97	1.56	6,938,500
6. iShares Russell 2000 Index	2.26	8.35	4,343,300
7. Financial Select Sector SPDR	0.68	0.98	1,867,700
8. iShares MSCI Brazil (Free) Index	7.94	4.72	1,515,800
9. Materials Select Sector SPDR	1.54	10.57	1,276,000
10. iShares S&P 500 Index	1.10	-3.26	1,257,100
Source: Morningstar