In the late 1990s, wealth manager Tom Lydon got fed up with mutual funds. Lydon, the president of Global Trends Investments in Newport Beach, Calif., had long adhered to the investment discipline of tactical trend following, a strategy that assumes trends don't continue on the upside forever. But his strategy had become harder to follow in the mutual fund space, with its constant closings, restrictions on trades, redemption fees, and style drift.

So when the tech bubble burst at the end of the last decade, he was ready to make a change. "Since 2003, we've shifted from 90% mutual funds to 90% ETFs, which is where we still are today," he says.

Lydon is a 25-year veteran of the financial services industry, having gotten his start at Fidelity Investments' institutional division before starting Global Trends Investments in 1996. Perhaps of greater impact was the time he spent with Dick Fabian. Some readers will remember Fabian and his Telephone Switch Newsletter, as it was called in the '80s. Lydon, after his stint with Boston-based Fidelity, moved to California and helped Fabian build his management business, and what he learned was the whole discipline of trend following. As a disciple of this approach, Lydon began incorporating moving averages into his current investment strategy.

But gradually, he found the mutual fund world becoming ill-suited to the kind of investing he wanted to do. In the late '90s, some of the best-performing midcap, small-cap and international funds either stopped accepting new assets or began to impose high redemption fees, which made his tactical investing considerably more difficult. The rules set by these funds and the custodian marketplaces where they were sold didn't work for all advisors' investment styles.

"For decades there's been a love/hate relationship between advisors and mutual funds," says Lydon, "as the funds insist advisors hold their shares for extended periods of time."

In a 2007 study by the federal government's Thrift Savings Plan, large mutual fund companies were found to control too-frequent trading by either assessing additional fees for redemptions or by restricting trading-for example, by allowing no more than one purchase and sale of a fund within a specified time period.

At the same time Lydon was discovering he could no longer use certain mutual fund managers, he was becoming more aware of ETFs. "With ETFs, there are no rules since the securities are traded on the exchanges. We can buy and sell them in the same day [without penalty] if we want to," he says.

Still, the move from funds to ETFs poses challenges of its own. "Like many advisors, we were custodying with Schwab in the late '90s and early 2000s," says Lydon. "When the market declined during 2000-2002, we were mostly in cash and beginning to notice ETFs. Although there weren't the number of ETF choices back then that we have today, there were a decent number of domestic asset class choices, and the pricing process through Schwab worked well. Our challenge was educating clients about the benefits of ETFs, but once clients understood those benefits-including ETFs' low costs-they trusted that we were doing the right thing."

So enamored was Lydon with the ease and convenience of ETF investing, he started his own ETF Web site: www.etftrends.com. "As time went on and more and more ETFs became available and were working well for our clients, we realized there wasn't one place you could go to get information about ETF providers and product development efforts. We saw other advisors going through the same search. So in 2005, we threw together a blog about ETFs. We let our fellow advisors know and encouraged them to share stories they could upload about their experience with ETFs. The blog became a Web site, and the site became helpful for our clients, too. Rather than educating them one-on-one about ETFs, we could direct them to www.etftrends.com instead."

The ETF site eventually evolved into much more, though. As Lydon and his followers added more stories to it, major search engines began noticing. "If we added two stories a day, we'd get twice the traffic; four stories and it doubled again. That's when I realized how much of a demand there was for education on ETFs. Initially, I was just creating an educational tool for clients who would refer their friends to the site and to Global, but we found the site was a great tool for other advisors, too. I didn't think about the fact that we'd get good PR from it. Now I get calls from print, TV and radio media looking for ETF commentary."

One of the site's resources-what Lydon calls its "ETF Analyzer"-reflects Fabian's influence. The analyzer is a listing of all ETFs with at least $50 million and their 200-day moving averages, which are the basis for Lydon's investment discipline.

"We found in designing it that if you're trying to manage your portfolio and you have core holdings-but are looking to find areas that might show new trends to the upside-the analyzer is a great way to do it," he says. "You can look at an ETF's 200-day moving average and see what areas might be developing a new uptrend. This is what we do for our own client portfolios ... we only own ETFs above their 200-day moving average trend line."

But wouldn't this imply that ETFs that drop below their trend line are then sold? "Not necessarily," says Lydon. "We sell when the ETF either goes below its 200-day moving average or when it drops 8% off its high-whichever happens first."

Lydon offers as an example how emerging markets like China were 30%-35% above their moving averages in 2007. "If we'd stuck to using just the moving average trend line and no 8% stop-loss discipline, we would have given back 35%," he explains. "And since ETFs are traded on the exchanges, we can buy and sell in the same day if we want to. So we really believe that, for advisors wanting to implement their own strategic or tactical allocation model, ETFs really are the answer."

According to a 2009 study of active and passive investment strategies by Winans International-an investment management and research house-from 1988 to 2008 a 200-day moving average strategy produced average annualized returns of 13% while a buy-and-hold strategy returned only 4%. Of course, the 2008-2009 stock market by itself provides the perfect testing ground for Lydon's moving-average strategy. Did it protect his clients?

"We dodged a bullet," he says. "As of February 28, 2009, we were down 2.6% year to date, while the S&P was down over 18%. In 2001 and 2002, we were down by single digits when the market was down considerably more. So in the last ten years it's been difficult to make money, but since the end of 2000, we're up 2.9% annualized, net of fees, while the S&P is down to the tune of 7% per year."

In spite of the fact his clients earned just short of 3% a year, they're nonetheless enjoying a considerable alpha effect from Lydon's strategy. It isn't just the sell discipline that has helped, he says, but "by having all asset classes, sectors, commodities and currencies available to us via ETFs, we've been able to reduce risk and provide opportunities to clients when trends develop."

And that's happened during a very tough, challenging time in the market when even some money market vehicles have seen share values sink below $1. Lydon's common sense told him to move clients from diversified money market funds to U.S. government money market funds in early 2008. "We're barely getting 1% interest, but the clients feel that even if a money market is paying zero percent and their money is safe, they're OK with that."

Lydon recently co-authored the book iMoney: Profitable ETF Strategies for Every Investor, published in the summer of 2008 by FT Press. He sees an even brighter future for ETFs, including the introduction of new indexes and asset classes. For example, new "sShare" ETFs from Pax World Management will target companies with strong environmental and social governance criteria and equal sector-weighted ETFs have been introduced by companies like Alps Holdings.

Where will the money come from to buy these new ETFs? Says Lydon, "We know that there's three to five trillion dollars on the sidelines now, and at some point in time this money will come back to the market. When it does come back, the average individual investor-and advisors too-will be better educated about the benefits of ETFs. When you see big names like PIMCO and Schwab entering the ETF marketplace, it's clear to me that ETFs are the most innovative investment vehicle we've seen in the last 50 years."

And they work well with a moving average investment strategy, too.

An independent advisor since 1981 and journalistic voice since 1993, David J. Drucker, MBA, CFP, is a frequent speaker at industry events.  To learn more about his availability for your next event, contact him through www.DavidDrucker.com.