Exchange traded funds have become so popular with mutual fund managers that at the end of last year, 17 of the 20 largest fund companies were using them, according to a recent study.
Columbia Management Advisors LLC of Boston, a unit of Bank of America Corp. of Charlotte, N.C., held the most assets in ETFs at $7.93 billion spread among 147 individual funds, according to the Sept. 10 study, by State Street Global Advisors of Boston.
It held 86 ETFs from Barclays Global Investors of San Francisco and 21 ETFs from SSgA.
The Vanguard Group Inc. of Malvern, Pa., and Invesco PowerShares Capital Management LLC of Wheaton, Ill., made up the next-largest contingents.
Fidelity Investments of Boston held the most individual ETFs (171) but held just $593.2 million in those ETFs, according to the report.
It held 94 ETFs from Barclays and 29 ETFs from SSgA. Fidelity also held ETFs from Vanguard, Invesco PowerShares and Rydex Investments of Rockville, Md.
While such acceptance of ETFs appears to indicate endorsement of their value by active managers, at least one financial adviser said their use raises important questions.
"It seems to me it's something of an admission that stock selection is hard," said Rick Miller, chief executive of Sensible Financial Planning and Management LLC in Cambridge, Mass., which oversees $170 million for clients.
Investors entrusting "active" managers with their assets may find such an admission troubling, said Mr. Miller, who is a proponent of index investing.
Of course, a lot depends on how mutual fund managers are using ETFs.
The study found that one of the primary ways fund managers use the funds is for cash equalization or parking cash in ETFs for short periods until the fund invests in individual stocks.
That is a perfectly valid investment strategy, said Jeff Tjornehoj, a Denver-based analyst with Lipper Inc. of New York.
Where a mutual fund's use of ETFs is questionable is when a fund manager appears to be making long-term bets on ETFs versus individual stocks, he said.
"I do sympathize" with investors who believe they are paying their fund manager to pick stocks, not ETFs, Mr. Tjornehoj said.
He emphasized, however, that it can be perfectly valid for a fund manager to hold ETFs as part of a long-term sector rotation strategy — as long as that strategy is made clear to the investor.
"I don't think it's that harmful to the investor when all is said and done," Mr. Tjornehoj said.
One fund company that believes in holding ETFs long-term is Arrow Investment Advisors LLC of Olney, Md., which offers the Arrow Funds.
A small firm with just three funds and total assets of $465 million, it is trying to carve out a niche for itself with funds that invest primarily in ETFs.
"I use ETFs because they give me the ability to move in and out of a sector quickly," Joseph Barrato, chief executive of Arrow, said in a statement that accompanied the SSgA study.
Mutual fund managers' using ETFs to make sector bets doesn't bother Nicholas Spagnoletti, a partner at Macro Consulting Group LLC, a Parsippany, N.J.-based firm that oversees $350 million in assets.
"I think in certain cases ... an ETF is fine, because it's difficult to be an expert in every sector," he said. "ETFs are fine to use in those situations, but it has to be disclosed."
Despite the concerns, it seems almost inevitable that mutual funds will continue to ratchet up their use of ETFs.
"I do expect that we will see some products out there trying to use ETFs more creatively," Mr. Tjornehoj said.
One such product is a fund of funds that invests in ETFs.
J. & W. Seligman & Co. Inc. of New York was the first to launch such a fund, in October 2006. Its five TargETFunds have total assets of $176 million.
Other fund companies that have launched similar funds include Federated Investors Inc. of Pittsburgh, which has three such funds with total assets of $30 million, and Wilmington Trust Investment Management LLC of Atlanta, which has one fund with $30 million in assets.
Upstart ETF providers that wish to capitalize on the growing appetite of mutual funds for ETFs, however, may be disappointed.
Mutual funds seem most interested in those ETFs from the two biggest ETF providers, Barclays and SSgA.
The iShares Russell 2000 ETF (IWM), from Barclays, was the most popular ETF among mutual funds by assets, with funds holding a total of $1.8 billion in the ETF, according to the SSgA study. Barclays' iShares S&P 500 ETF (IVV) came in second with $1.4 billion in assets, followed by the SPDR S&P 500 ETF (SPY), from SSgA, with $1.3 billion in assets.
E-mail David Hoffman at email@example.com.