Well-heeled individuals are fueling the explosive growth of the exchange-traded fund, now a $700 billion business that began in the early 1990s.

"High-net-worth individuals are certainly embracing ETFs," says Robert Testa, an analyst with Cerulli Associates. The Boston-based consultant is studying the growth of the ETF, which has seen an explosion in assets for about a decade. Market observers say the market's woes in 2008 increased the ETF's popularity. That's because well-heeled investors have become more risk adverse.

"Another factor that could be driving some of the ETF usage is a move toward more transparency and lower costs to clients that resulted from the market downturn," according to a recent Cerulli Associates report.

The staggering losses in client portfolios in 2008, the report continued, have led high-net-worth investors to use more ETFs. They offer "inexpensive exposure to market segments that are typically expensive to manage actively, including international and emerging markets," according to the fourth quarter edition of Cerulli Associates' Managed Accounts, an internal publication.

How did ETFs become popular with rich individual investors?

The ETF portfolio was almost solely an institutional investment, used by hedge funds and endowments in the early 1990s when it was introduced. But now it has become a favorite of the well heeled and their advisors, who have many more ETF options.

"It's not surprising to see its popularity with the rich and their advisors. This has been going on for a while now," says Scott Burns, director of ETF analysis at Morningstar.

ETFs, he notes, generally have considerably lower expense ratios than conventional mutual funds. "The price advantage is a big issue with advisors and their rich clients as are the tax planning features," he says.

Surveys show the separately managed account and the ETF have become the recent favorite investment tools of high-net-worth investors, Burns says. The typical investor in this group, he adds, generally has at least $10 million of investable assets. Many of these people, observers say, felt they were burned by conventional funds in the 2008 blowup.
"In an era of renewed emphasis on risk management, ETFs are a good fit because of their transparency," says Carl Resnick, a managing director and portfolio strategist for Rydex/SGI, one of the smaller players in the ETF business with some $6 billion in assets.

Rydex is focusing on selling ETFs to rich individuals and their advisors-clients who typically have between $100 million and $1 billion to invest, Resnick says. The specialization of ETFs is one reason why high-net-worth investors are now buying the product, he says.