Exchange traded funds (ETFs) are becoming the fastest growing of the three major fund types used by retail investors.

A recent study by Financial Research Corp. projected that ETFs will represent 6.8% of the total assets in retail investments by 2012, reports Eric Rosenbaum for IndexUniverse. This projection shows ETFs overshadowing index mutual funds in market share for the first time.

However, there is a caveat. Data for ETFs cannot be separated into retail and institutional investors, whereas mutual funds are generally retail investments, although some mutual funds do offer institutional share classes.

Since 2004, ETFs have accumulated 20% per year in fund industry net sales, as compared to figures for active and passive mutual funds. By 2007, ETF annual net sales began to rival that of actively managed mutual funds. It is no wonder when considering active funds’ drop of 20% in net sales yearly. It is predicted that ETFs will surpass mutual funds in annual net sales for the first time by the end of this year.

During September and October, $61 billion found its way into ETFs from retail and institutional investors while $126 billion was funneled out from traditional mutual funds.

While index mutual funds are dallying in core asset classes, product development in passive ETFs has spread to almost all sectors of the market. Thus, ETFs are seen as aggressive invaders on fund territories across the board.

As a result of a fast changing retail portfolio construction, widespread adoption of ETFs could mean great long-term growth potential for ETFs.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.