Investors have been pouring into ETFs, and plenty of advisors have been joining the crowd. According to a survey by Charles Schwab, 85 percent of RIAs have used at least one ETF. While some advisors use ETFs exclusively, most portfolios include mixes of investments. In a common strategy, an advisor will start with a core of actively managed funds and then use ETFs to fill in satellite niches. Other advisors hold a core of ETFs and buy active funds for specialized needs. “It is unusual for us to work with an advisor who uses just ETFs or just active funds,” says Sue Thompson, managing director of BlackRock, which runs the iShares family of ETFs.

Some financial advisors profess to being agnostic, holding no clear preference for ETFs or active funds. The aim should be to evaluate each fund objectively, says Marvin Appel, CEO of Appel Asset Management, a financial advisor in Great Neck, N.Y. Appel starts by selecting an asset class for a portfolio. Then he assesses potential ETF and fund holdings based on their risk-adjusted returns. He picks the choice with the best track record. Sometimes the selection is an ETF, but most often Appel takes actively managed funds. “The best mutual fund managers are able to deliver returns that are comparable to the benchmarks but with a little less volatility,” he says.

An active fund that Appel likes is First Eagle Global (SGENX). The fund holds a broadly diversified collection of undervalued stocks. To control risk, the portfolio managers often keep big cash stakes and holdings of gold and gold companies. Most often the fund's strategy has worked. During the 10 years ending in June, the fund returned 12.8 percent annually, outdoing 98 percent of its peers in the world allocation category, according to Morningstar. In the downturn of 2008, the fund lost 21.1 percent, topping the MSCI World benchmark by more than 19 percentage points. “First Eagle gives you lower volatility than you can find with comparable ETFs,” says Appel.

Advisors who prefer active funds often turn to ETFs when they are the only vehicles that target particular niches. Appel has held WisdomTree Emerging Markets Equity Income (DEM), which buys dividend-paying stocks. The fund has delivered higher returns with less volatility than most competing emerging markets mutual funds.

Some advisors have begun buying currency ETFs, which enable investors to own Swiss francs or Australian dollars. No active mutual funds provide direct plays on individual currencies. By holding the ETFs, investors can profit from a decline in the dollar, says Lou Stanasolovich, president of Legend Financial Advisors, based in Pittsburgh. He has held CurrencyShares Swiss Franc (FXF). “You are likely to see a dipping of the U.S. dollar, which means that foreign currencies will appreciate,” says Stanasolovich.

Stanasolovich has also been buying agriculture ETFs, including Market Vectors Agribusiness ETF (MOO). He says that demand for agricultural products is growing rapidly as consumers in China and India improve their diets. The best way to play the trend is with ETFs, he says. “We really don't have a good open-end agriculture commodity fund,” he says.

While commodity and stock ETFs have been attracting more followers, many advisors still prefer actively managed bond mutual funds. Some advisors remain loyal to star bond funds, such as PIMCO Total Return (PTTAX), which has topped the benchmarks consistently for years. Other advisors argue that ETFs are not well-suited for bonds because it is difficult for passive portfolios to mimic the large fixed-income markets. Consider that to track the S&P 500, an ETF portfolio manager can simply buy the stocks of the 500 companies in the benchmark. But it is next to impossible to hold all the bonds in the municipal universe, which includes tens of thousands of names, including many that rarely trade.

Among the advisors who hold some active bond funds is Rick Ferri, who founded Portfolio Solutions, an investment advisor in Troy, Mich. For most asset classes, Ferri uses only ETFs and index funds. Those provide low fees and broad diversification, he says. But for municipal bonds, he prefers Vanguard Intermediate-Term Tax-Exempt (VWITX), an actively managed fund. “The ETFs tend to be more expensive and give less diversification,” he says.

Vanguard Intermediate-Term holds 2,500 municipal bonds and charges an expense ratio of 0.20 percent. In comparison, Market Vectors Intermediate Municipal Index (ITM), an ETF, holds only 395 bonds and has an expense ratio of 0.24 percent.

Ferri also prefers active mutual funds for investing in high-yield corporate bonds. He holds Vanguard High-Yield Corporate (VWEHX), an active fund that has an expense ratio of 0.25 percent and holds 325 bonds. In contrast, SPDR Barclays Capital High Yield Bond (JNK), an ETF, charges 0.40 percent and has 223 bonds.

Many advisors have begun using ETFs and broad index funds to cover large-cap U.S. stocks. More than 40 percent of all assets in large blend funds are in passive portfolios, according to Morningstar. Advisors argue that it is hard for portfolio managers to outperform large-cap benchmarks. “I don't see how a large-cap manager can add value because the U.S. market is so heavily researched that all the information is well-known,” says Benjamin Tobias, a financial advisor in Plantation, Fla.

Tobias says that managers have an easier time outperforming benchmarks in foreign markets. Overseas stocks are less closely researched, and there have often been times when managers have outdone benchmarks by overweighting countries or regions. Tobias owns T. Rowe Price International Stock (PRITX), an active fund. In recent years, the fund has outdone competitors by overweighting growth stocks in the emerging markets.

Tobias believes that the T. Rowe Price fund will outdo the benchmarks in coming years. But to hedge his bets, he also holds international ETFs in some portfolios. A favorite holding is iShares MSCI EAFE Index (EFA). By holding more than one international fund, Tobias figures that he is providing broad diversification. And if his active manager misses the market, clients will not suffer big disappointments.