When State Street Global Advisors launched the first exchange-traded fund in January 1993, it was marketed primarily to institutions as a way for them to execute sophisticated trading strategies such as hedging. Finally, there was a low-cost, tax-efficient investment vehicle they could trade like a stock. Over the next few years, Barclays launched its World Equity Benchmark Series (later to be renamed the iShares MSCI Index Fund Shares), and a few other asset management firms began following suit. For many years, there was no denying it: The funds were off to a slow start.

But when the market took a turn for the worse in the summer of 2007, and advisors were desperately trying to keep clients from jumping ship, ETFs became the vehicle of choice. Suddenly, investors were taking real interest in the benefits of ETFs: low cost, tax efficiency, transparency and liquidity, to name a few. At a time when the market was swinging by hundreds of points a day, you could buy or sell a position and not wait for the market's close to find out the price. You could short ETFs; you could write options against them to hedge a position. Trading volumes soared to 2.68 billion shares per day at the market's low in March 2009, from 714 million shares per day in October 2007, according to Morningstar. And ETF assets, which had been gaining heft steadily for years, hit an all-time high.

Today, 789 ETFs hold assets of $702.4 billion-a more than 90% rise over the past three years. Although this is meager compared with the $7 trillion mutual fund market, industry analysts now consider ETFs the most significant product development since mutual funds. Niche products are popping up all across the investment spectrum, as providers find creative-and sometimes controversial-new ways of marketing this asset through leveraged products, 401(k) plans and even active management.

The very first ETF, the SPY, still sits at the apex of the ETF universe with $69 billion in assets, accounting for 10% of the industry's aggregate holdings. But little else has remained unchanged in this part of the market filled with rapid innovation, infinite opportunity and passionate debate.

DRIVING THE NEW VEHICLE

During the 18-month recession, ETFs accounted for 30% to 40% of trading volume and were the single biggest driver of flows. Thanks to educational efforts by fund providers and analysts that had been in full force long before the market began to sink, investors had begun to recognize the unique qualities ETFs offered. "The markets were moving so fast, even 700 or 800 points in a single day, that people started to realize they can control the entry point into and out of the market using ETFs," says Tony Rochte, senior managing director at State Street Global Advisors, one of four ETF providers that dominate the market. "In mutual funds, the only thing you know is you can trade when the market closes."

While liquidity drew many to these funds last year, their transparency also played a key role in attracting dollars. Because they are traded on a daily exchange, ETFs must report their performance and holdings each day on the fund's website. This transparency became prized after scandals ranging from Madoff to Stanford and beyond prompted investors to demand to know where-and how-their dollars were being deployed. The result: massive flows into fixed-income ETFs which, despite accounting for only 69 of the nearly 800 ETFs, hold nearly 13% of the industry's assets ($90.9 billion), according to Morningstar.

Financial advisors began reevaluating what their clients had said about their risk tolerance, Rochte says, and bond ETFs became an important part of advisors' tool kits. Many RIAs also turned to fixed-income ETFs, as it became increasingly difficult for them to justify charging clients a 1% fee, while they were earning just .08% in a money market fund, says Sue Thompson, national sales manager of the RIA team for the U.S. iShares business at Barclays Global Investors, another top player in this space.

And so fixed-income ETFs became one of the most commonly traded products of the recession. Short-term Treasuries were the funds of choice for many as the SPDR Barclays Capital 1-Month T-Bill, for instance, traded more than a million shares per day and now holds assets upward of $1 billion, according to Rochte.

Bond ETFs were the top asset-gathering class in the ETF universe through the end of August. Nevertheless, the bond ETF market is still relatively small with plenty of room for growth. But there are some hurdles. Since many bonds, such as municipals, become fully subscribed the day they are issued, providers worry that a lack of new issues could curtail the number of new products that hit the market. "Supply and demand have been a tremendous concern over the past 18 months," admits Michelle Nigro, head of sales for financial advisor services at Vanguard, another large contender in the ETF universe and a provider of 39 fixed-income ETFs.