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(MIKE SEGAR/Mike Segar/Reuters)
(MIKE SEGAR/Mike Segar/Reuters)

ETFs: Industry's death greatly exaggerated Add to ...

Last year wasn't kind to the exchange-traded fund industry. ETFs -- baskets of stocks and other assets that resemble mutual funds but trade throughout the day on stock exchanges -- used to be praised for their low cost and simplicity, since they generally tracked established indexes.

Yet, new funds were widely ridiculed last year for appealing to an ever-narrower base of investors and piggy-backing on the latest trends (leveraged bets on the CBOE volatility index, anyone?). And the enormous losses caused by an alleged rogue trader at UBS were pinned to the use of exotic "synthetic" ETFs, putting the entire industry on the defensive for offering products that were too complex and, well, money-losers.

With criticism coming from every direction, it is little wonder that some observers believed that the growth of ETFs was over. The numbers backed them up: In 2011, ETF assets grew just 3 per cent, according a report by Moody's Investors Service. That's down from growth of about 85 per cent between 2008 and 2010, when investors flocked to passively managed ETFs in light of the financial crisis and devastating bear market.

"Last year was a mixed year for ETFs," says Moody's vice president Rory Callagy, in a note. "The European sovereign debt crisis, concerns about use of derivative in synthetic ETFs and elevated market volatility all proved to be strong headwinds against asset growth."

Yet, Moody's believes that the industry is far from decline. They argue that last year's pause in growth had less to do with bad optics and failed initial public offerings, and more to do with the fact that assets within existing ETFs failed to grow much -- reflecting relatively little movement in major indexes. After all, the S&P 500 was flat last year and European indexes were disasters.

Moody's points out that the ETF industry is actually still thriving. Even last year, a dud, still attracted about $148-billion (U.S.) in new cash and launched more than 500 new products. "Fundamentals point to further positive growth trends this year, though the pace of growth likely will continue to be tempered by macroeconomic uncertainties and credit pressures on sovereigns and banks," the credit rating agency said in a release.

Meanwhile, ETFs should continue to enjoy popularity based on what investors were attracted to in the first place: Low costs and the relatively poor performance of actively managed funds.

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