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When It Comes to ETFs, How Much Is Too Much?

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With all the optimism over the growth of exchange-traded funds comes a less obvious question about whether the industry actually might be growing too fast.

It's what fund industry pioneer Jack Brennan calls "proliferation risk," or the worry that the 1,445 funds available might be a few too many.

"Products keep coming out and the proliferation is worrisome," Brennan, the chairman emeritus at the Vanguard Group, said at the Index Universe Inside ETFs conference. "It puts a burden on all of you to understand what's really value-added from a new product development standpoint and what's just another proliferation."

Though ETFs are more commonly viewed as investment products used to track basic indexes like the Standard & Poor's 500 and its 10 individual sectors, along with commodities and fixed income, some have become more exotic in nature.

Some are funds that use leverage to pay off two or three times a down move in the market.

Others invest in markets that may be unfamiliar to retail investors.

For instance, one of the most closely watched in recent days, according to industry tracker XTF, is a hedged fund on the Japanese stock market.

(Read More: When It Comes to ETFs, Know What You Own)

Brennan worries in particular about the leveraged funds.

"That's going to affect all of us, because the mud from all of those products is going to splatter on the the great, disruptive ETF," he said.

He uses the term as a compliment for ETFs, which he said have been one of the "few great and disruptive innovations in the retail (investing) business."

But that doesn't mean he isn't concerned about some of the underlying trends.

Actively managed ETFs are few but also growing and "an oxymoron to me," Brennan said.

The strategy runs counter to a traditional passive ETF in that it can deviate from a basic index and seek to time the market and employ a manager to run the fund.

(Read More: ETFs vs Mutual Funds: The Debate Heats Up)

"It's counter-intuitive. One of the reasons you index is to take manager risk out of the equation," Brennan said.

Some of the advisers at the conference, though, said they see active ETFs as a growth area.

"We have seen a willingness from clients to look at active," said James Ross, global head of ETFs at State Street Global Advisors. "We've had some very interesting dialogues with some of our clients at some more outcome-oriented strategies. I do think long-term, looking out 10, 15, 20 years I'd be hard-pressed to say active ETFs don't gain a fair amount of success in this business."

McKinsey & Co., in fact, recently estimated that active ETFs would have $500 billion under management by 2020, from their current level of just $10 billion.

"It's a total head-scratcher," Brennan said. "I worry it could affect the credibility of the products you use for your clients."

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