AUTHOR: Grail Advisors

METHODOLOGY: Grail examined the fund flows and performance of exchange-traded funds from 1998 to 2008 to come up with an overview of this market, which had more than $725 billion in assets by the end of 2008, according to Grail's most recent calculation. The research firm, which markets actively managed ETFs, also shared some insight into what is ahead for the financial instrument.

MAJOR FINDINGS: ETFs' popularity is growing among traditional asset managers, finanancial advisors and retail investors. ETFs and exchange-traded notes (ETNs) drew $176 billion in net inflows last year, despite the difficult market. Actively managed ETFs, which debuted in 2008, are starting to gain some traction. At the end of 2008, there were 13 active ETFs on the market with about $240 million in assets.

Recent hot spots for ETF investors include inverse- and long-leveraged ETFs, which now hold more than $22 billion in assets in the U.S. These funds are under regulatory pressure and have been removed from some sales platforms.

ETF growth is expected to outpace that of several financial products. Between 2007 and 2009, ETFs are expected to grow by 27%, compared with 22% in the same period for 529 plans; 18% for hedge funds; 16% for managed accounts; 12% for closed-end funds; 10% for mutual funds; and 8% for variable annuities.

There are now about 800 different ETFs trading in the U.S., tracking a wide range of financial instruments: U.S. large-cap equities, emerging-market stocks, gold and revenue-weighted versions of popular stock indexes. ETFs are increasingly being used as building blocks for multi-asset class portfolios, including life cycle-based and tactical allocation strategies implemented within single ETFs, funds of ETFs and ETFs of ETFs.

ETFs have less of a tax drag than ordinary mutual funds. Unlike mutual funds, trading happens between shareholders, and the fund does not need to sell stock to meet redemptions. Also, because nothing in the underlying ETF portfolio changes when an investor buys or sells shares, the fund avoids realizing a gain on its holdings.

THE AUTHOR SAYS: "Considering the impressive inflows into 2008's difficult market, it seems inevitable that ETF assets will continue to multiply. Market appreciation is uncertain, and so are immediate flows into actively managed funds, but it's reasonable to expect worldwide ETF assets to reach the $1 trillion milestone in the very near term."