Exchange-traded funds, a relatively cheap and tax efficient way for individual investors to invest in equities while maintaining a degree of diversification in portfolios, are becoming more popular among wealthier investors and their advisors.

A recent survey of 2010 data from financial advisors conducted by Scott Smith, associate director of the intermediary practice at Cerulli Associates, found that the investor group that had the highest percentage of ETFs in its portfolios turned out to be individuals with between $5 million and $10 million in assets under management. 

These deeper-pocketed investors had an average of 14.2% of their assets invested in ETFs. This represented a big jump, Smith told On Wall Street, from 2009 when that same group of investors only put 5.6% of assets into ETFs.

This year’s ETF allocation was close in size to the 19.7% of assets these same investors held in equities mutual funds and exceeded the 11.2% of assets they put into fixed-income mutual funds.

Investors with between $1 million and $5 million in assets under management, while putting a smaller share of assets (8%) in ETFs -- still had almost double the 4.5% ETF allocation of small investors with less than $250,000 to invest. This $1 million to $5 million only allocated 7.2% of its total assets under management to ETFs in 2009.

Meanwhile, clients with between $250,000 and $1 million in invested assets also had a larger ETF allocation, with 7.5% of funds invested in ETFs. 

However, among clients with $10 million or more in invested assets, Smith found a substantial drop-off in ETF allocation, with this group only allocating 4% of their portfolios to ETFs.

Interestingly, the allocation of equity mutual funds in client portfolios initially increases as the assets under investment grow. Among smaller investors with between $250,000 and $1 million in assets, 31.1% of their portfolio was dedicated to equity mutual funds. Those with between $1 million and $5 allocated 26.1% of their nest eggs to the funds and those with between $5 million and $10 million set aside 20.7% to equity mutual funds.   

But with fixed income mutual funds, there is a bulge in the middle. Small investors with $250,000 or less to invest, allocate 11.1% to fixed-income mutuals, while wealthy investors with more than $10 million in their portfolios invest just 6.3% in those funds. However, investors with $250,000 - $1 million, with $1 million - $5 million and with $5 million - $10 million portfolios allocated, respectively, 14.5%, 12.0% and 11.2% to fixed-income mutual funds.

Smith said that the increased allocation to ETFs among wealthier investors appeared to come “directly at the expense of mutual funds,” on an almost one-to-one basis.

Individual equities also were most popular among the middle range of investors, with the investors in the $1 million to $5 million asset category being the biggest individual stock buyers at 14.3% of portfolios, and the smallest and largest portfolio groups being the least active individual stock buyers, at 7.9% and 8.6% respectively.

Smith’s research also finds that those investors who favor ETFs over mutual funds tend to be younger and better educated -- not just wealthier.

This is supported by earlier research by the Investment Company Institute, which found that the median income of mutual fund investors is $80,000 a year, compared to $130,000 a year for ETF investors and that the median amount of invested assets of mutual fund investors is $200,000, compared to $300,000 for ETF investors.

Smith said independent advisors are generally happy with the growing interest in ETFs among larger investors. “I think these advisors as a group are more concerned about expenses, and like ETFs for that reason. They and their clients don’t like all the hidden expenses in mutual funds, especially when they aren’t performing well,” said Smith.

Of course, for advisors, the increasing interest among wealthier clients in ETFs is also likely to mean more work. Clients who invest in ETFs also tend to be interested in and involved in their portfolios and to contact their advisors more often.