ETFs: Forging New Frontiers
From OWS Magazine | May 2006 Issue
By Tony Chapelle
May 1, 2006 - After a 13-year meal in which they gobbled up nearly every equity index in sight, exchange-traded funds have acquired a more refined appetite. Since State Street Global Advisors introduced ETFs in 1993, most creators of these stock-like investments have built them to include the same stocks that appear in well-known, broad indices. Now, they've moved on to precious metals, commodities, currencies and even housing construction.
Next will be ETFs that aren't tied to indices at all, say fund designers and operators. "Instead of passive [indices] and enhanced or strategy-based ETFs, now there are [Securities and Exchange Commission] filings to get actively managed ETFs that do fundamental stock-picking," says Clifford Weber, senior vice president of the American Stock Exchange ETF Marketplace. "That's the next step. But it's some ways away."
For now, however, the industry is still finding ways to generate plenty of buzz over each new frontier it enters.
In the past 12 months, 52 ETFs have been introduced--of which 25 are based on industry sectors, according to Bear Stearns. For instance, in February, State Street Global Advisors came out with three ETFs that are benchmarked against specific industry sector indices created by Standard & Poor's. The SPDRs, as S&P ETFs are called, are in biotech (XBI), housing construction (XHB) and semiconductors (XSD).
Assets in ETFs in the United States grew by 31% in 2005 to $296 billion, according to the Investment Company Institute. The subset added another $19.3 billion in the first two months of this year.
Investors who are familiar with ETFs love these investment vehicles for their low costs. The average stock ETF has an annual expense charge of 0.35%, while the average traditional stock fund has an asset-weighted annual expense ratio of 0.95%.
ETFs carry none of the sales charges known as front- and back-end loads, the redemption fees that drag on for years, or the marketing fees that make traditional funds so lucrative for fund companies and brokers who sell them.
Silver
Investors eagerly embraced the six gold exchange-traded trusts that were launched during the past three years. The two U.S. versions, however, spent two years in limbo before being approved. Now, it's silver's turn. Last spring, Barclays Global Investors (BGI) filed to launch the first exchange-traded investment in silver. The iShares Silver Trust, an exchange-traded grantor trust, is still awaiting approval from the SEC. If accepted, it would trade on the Amex. The trust would let investors own 10 ounces of silver for each share they bought (without actually having to take possession) and then ride the daily London fix of the metal.
Since the time BGI--the world's largest issuer of exchange-traded investments--said it would launch the new trust, the price of silver, as of late March, has jumped 40% to approximately $10.50. That's because traders anticipate increased demand for silver bullion to back the retail and institutional investment. And the move may not be over. In March, analysts at Credit Suisse said silver's medium-term price could reach $15 due to the exchange-traded vehicle.
Still, not everyone is excited about the prospects of a silver ETF. Dan Colluton, lead ETF analyst at Chicago-based Morningstar, points out that the fund will have to sell off silver to pay its costs. That means the fund's assets will decrease over time, which could drag down the share price. Investors should be aware that the Internal Revenue Service considers silver and gold investments as collectibles, which are therefore subject to a 28% maximum tax rate rather than the 15% capital gains rate for investments held for more than a year. Unlike gold, silver isn't much of an inflation hedge. Silver prices are also notoriously volatile. "You're better off dodging this silver bullet," Colluton says.
Oil
At press time, three companies either had launched or planned to introduce a total of four exchange-traded commodities pools (ETCs) to track the price of crude oil. The first of these to make their debut was Brent Oil Securities (OILB), a Britain-based ETC that mimics the price of Brent crude oil futures. Brent Oil commenced trading last July on the London Stock Exchange.
Meanwhile, Amex officials at press time expected to begin trading the United States Oil Fund in April. That vehicle is administered by Victoria Bay Asset Management, a subsidiary of one of Africa's largest banks, and follows futures prices of West Texas Intermediate (WTI) light, sweet crude oil on the New York Mercantile Exchange.
Elsewhere, Madison, N.J.-based MacroMarkets has filed to launch two oil grantor trusts. Its Up Macro trust would use Treasury-based derivatives to give investors returns when WTI prices move up. The Down Macro trust would benefit investors when prices fall.
Colluton warns against most of the proposed oil vehicles. Most of them "were conceived as energy prices hit record highs," he says.
Currencies
In December, Rydex Investments launched the Euro Currency Trust on the New York Stock Exchange. The Trust sells shares equivalent to about 100 euros that increase or decrease against the daily exchange rate of the Federal Reserve Bank of New York.
Commodities
Deutsche Bank in February brought out the DB Commodity Index Tracking Fund (DBC), which is listed on the Amex. It tracks the six most liquid commodity futures contracts: crude oil, heating oil, gold, aluminum, corn and wheat. It's heavily weighted towards energy-related assets to roughly follow the proportion of the world's commodities production and inventory. "Commodities are heavily driven by energy," says Kevin Rich, the CEO of Deutsche Bank Commodity Services, which is the commodities pool operator.
Barclays is waiting to introduce its iShares based on the Goldman Sachs Commodity Index. |
