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It may have been 15 years since the first exchange-traded funds appeared in the United States, but these innovative products are finally starting to gain widespread popularity among IFAs.

The amount of assets under management held around the world in this fast-growing investment arena has risen by a staggering $350bn (£224.9bn) - 85 per cent - to $764.1bn during the last three years, and further increases are predicted.

In fact, this figure is expected to hit $1trn next year – and then double to $2trn by 2011, according to the latest ETF Landscape Industry Review, which has just been published by Barclays Global Investors (BGI).

The main factors it cites to support these predictions include regulatory changes being introduced allowing funds to make larger allocations to ETFs, the variety of indices covered, and the development of investment styles employing such products.

“We base our forecasts on the significant change in the way institutional and retail investors, asset managers, exchanges, brokers and index providers view ETFs,” states the report, adding that a number of new issuers are expected to appear.

It is easy to understand their attraction, insists Andy Gadd, head of research at Lighthouse Group. “ETFs are a useful addition to the choices available to fund managers and advisers,” he says. “They have allowed investors to be far more precise in their asset allocation, both domestically and around the globe, and to do so in a very cost-efficient manner.”

ETFs are effectively open-ended index funds that are listed and traded on exchanges in a similar way to stocks. They enable investors to get access to a wide variety of countries, asset classes and styles on a real-time basis.

The rising popularity of these products, which generally track the performance of a particular index or sector, has gone hand-in-hand with the recent bull run. As a result, many have enjoyed fantastic performances on the back of rising markets.

Transparency, liquidity, diversification, flexibility and cost-effectiveness are all regularly cited by ETF providers as reasons why they should be used for both strategic and tactical purposes.

In addition, they do not have any sales loads – just annual expenses, which generally range from 0.05 per cent to 1.60 per cent, while traditional mutual funds average between 0.39 per cent and 1.91 per cent.

However, the extreme turbulence witnessed in recent months has dampened enthusiasm in certain quarters with some advisers even questioning whether they are still viable investments now the global economy is hurtling towards recession.

In fact, it is fair to say these concerns have contributed to total assets under management falling by around 4.1 per cent year-to-date, although this is still significantly lower than the general market decline.

Even so, Hector McNeil, head of sales at ETF Securities, is adamant that ETFs are worth a look in the current climate. The way many of them operate, he suggests, makes them ideal holdings in which to place clients’ money.

“The current volatility in the markets means that ETFs are a fantastic way to get in and out of the different exposures as required,” he says, adding that a distinct lack of liquidity is making managed funds look distinctly unappealing.

“You would not easily be able to liquidate such a position if you thought markets were going to fall 10 per cent in a day,” he explains. “With an ETF you can buy at 8am and sell a few minutes later.”

Dee Brown, senior business development officer, wealth management, at iShares, agrees that they are suitable for investors wishing to quickly get exposure to certain asset classes, styles or sectors, but warns advisers to be careful when choosing.

“They need to look under the bonnet and make sure they know what they are getting in terms of the underlying indices,” he explains. “It is important to know where the exposure is coming from and whether it makes them feel comfortable.”

To some extent this is already happening, he adds, with many clients having started to ask far more probing questions about ETFs over the past six months. It is a trend he expects to continue.

“Advisers are searching a little deeper now and trying to understand the risks in their portfolios,” he explains. “They want to know about the risk of the underlying ETF and whether or not this overlaps with their current asset allocation.”

Mr Brown has also noticed a move towards apparently safer assets – and this is borne out by figures contained in the BGI report. “In the first nine months of 2008 we have seen investors move assets into fixed income and commodity exposure ETFs,” it states. “Assets in equity ETFs, especially global (ex-US) and Asian equity, have declined.”

Despite impressive global growth rates there is still room for improvement when you analyse the ETF assets under management in different areas of the world and realise that the US currently has a dominant 73 per cent share of the market.

Considering it was the first place that ETFs appeared back in 1983, it is perhaps unsurprising that it accounts for $564.4bn of the $764.17bn total global AUM, at the end of Q3 2008, according to BGI.

The next biggest market is Germany with $60.67bn, followed by France with $41.75bn, Japan with $27.56 and the UK with $24.98bn. Two others that have also made it into double digits are Canada and Hong Kong.

Mr Brown at iShares is confident that the enthusiasm for ETFs in the US will eventually be replicated overseas and insists there is already evidence that changes are taking place that will pave the way for a greater take up of these products.

The past decade, he points out, has seen ETFs go from being primarily an institutional tool to one that is mostly used by the retail market in the form of independent asset or wealth managers.

“Similar changes are happening in Europe as well and we are slowly moving away from an institutional base,” he says. “We are seeing platforms beginning to take shape and more advisers using ETFs. In fact, the growth rate in Europe is now faster than the US, although it is obviously coming from a smaller base.”

Globally, there are currently just less than 1,500 ETFs with 2,494 listings but more than 600 new products are expected to be launched – the vast majority of which are in the US, although 55 are on the cards for Europe and 60 for the rest of the world.

Geoff Penrice, an adviser with Bates Investment Services, is certainly positive on ETFs and cites the fact that 75 per cent of unit trusts often fail to beat the index as evidence that they should, on average, be able to outperform a collective investment.

Research over the past 40 years indicates that up to 90 per cent of the return from a portfolio can be attributed to the asset allocation rather than the skills of fund managers, he adds, so they are also a cheaper way of getting exposure to such assets.

“Although I still believe a well-run actively managed fund should outperform an index, ETFs can be very useful as a core holding and I am sure they will grow hugely more popular over the next few years,” he says.

Rob Griffin is a freelance journalist