Upstarts Launch ETFs -- With a Twist
New Products Aim to Beat
Traditional Stock Indexes,
Challenging Mutual Funds
By IAN SALISBURY
July 17, 2006; Page C7
While exchange-traded funds are gathering assets at a rapid clip, the market is still dominated by a few giants whose broad-market index funds hold the bulk of investors' money.
Recently, however, a small group of upstart companies have been trying to carve a niche for themselves, offering products they say can beat traditional benchmarks and compete for dollars not just with established ETFs but also with mutual funds run by money managers.
By far the largest of the newcomers is PowerShares Capital Management LLC, which in the past four years has launched more than 35 exchange-traded funds. In June, WisdomTree Investments Inc., a company advised by Wharton School Prof. Jeremy Siegel, launched its own family of ETFs.
Deutsche Bank AG has filed to offer a currency fund that will alter its bets based on shifting interest rates. And mutual-fund companies Rydex Investments, ProShare Advisors LLC and First Trust Portfolios LP have each launched offerings that seek to tweak or improve upon traditional stock-index funds.
"The ETF industry is moving beyond traditional indexes that are market-cap-weighted to more creative formulas," says Ronald DeLegge, publisher of ETFguide.com. New products offer stock-picking strategies or "active management in an ETF shell," he adds.
Exchange-traded funds resemble index-based mutual funds but trade on an exchange like a stock. ETF assets reached about $325 billion in May, according to the Investment Company Institute.
Though that is a drop in the bucket compared with the $9.32 trillion in mutual funds, ETFs have been growing quickly -- increasing 36% during the past 12 months.
The growth has led a number of companies to want in on the act. The problem? While traditional mutual funds hire money managers to pick stocks, giving investors an endless array of styles and names from which to choose, the ETF's legal structure makes such "active management" difficult.
So far, the Securities and Exchange Commission has approved only funds that aim to track indexes, such as the Dow Jones Industrial Average or the Nasdaq 100.
Those benchmarks are relatively few in number and limited in their appeal to investors. This has meant that while established broad-market ETFs, such as State Street Global Advisors' "Spider" and Barclays Global Investors' iShares Trust S&P 500 Index Fund, are swollen with cash, there isn't that much room for new products.
One solution is funds that track ever-more obscure indexes. There is a small army of ETFs that follow just one sector, like consumer goods or drug companies. But lately fund companies have been trying a third tack -- tweaking the established indexes in the hope of offering investors better returns.
"If ETFs are only based on benchmark indexes, there is only the need for so many," said Bruce Bond, president of PowerShares, whose funds have accumulated about $5.9 billion in assets since the company was founded in 2002.
While much of the money in ETFs comes from large institutions that use the funds as tools to "park" their cash in the stock market when it isn't invested in individual stocks, many of the new funds are aimed at retail investors attracted to traditional mutual funds.
"We are trying to compete for actively managed money," says Dan Waldron, vice president of ETF product development for First Trust Portfolios LP. "Until the SEC relaxes its requirement that all ETFs be index-based, we are going to get strategy-based concepts."
Among the new "enhanced" ETFs, WisdomTree and the PowerShares RAFI products are based on the notion that market capitalization, the measure used to weight many traditional indexes like the S&P 500, doesn't reflect companies' sizes and strengths as well as fundamental factors like dividends, revenue or cash flow.
There are also funds whose tweaks to indexes might be more useful as short-term investment tools than as long-term strategies: ProShares recently launched funds that double the daily performance of well-known benchmarks, as well as funds that provide inverse returns, so that if stocks fall, the ETF's investors gain.
Other funds use formulas to select baskets of stocks, often from a pool of companies that belong to a well-known index.
First Trust recently launched the DB Strategic Value Index Fund, an ETF that follows a basket of 40 stocks chosen from the S&P 500 for their price-to-earnings ratios.
The largest family of "enhanced" ETFs remains PowerShares Intellidex funds, which use an algorithm licensed from the American Stock Exchange to try to pick stocks that will outperform their peers. PowerShares got a big vote of confidence from mutual-fund company Amvescap PLC in January. Amvescap agreed to buy the Wheaton, Ill., concern for an initial price of $60 million plus incentives.
While PowerShares offers a slew of ETFs, in terms of assets, it is well behind Barclays PLC's Barclays Global Investors, State Street Corp., and Vanguard Group Inc. And each of these has remained aloof from "enhanced" or semi-actively managed products.
"We have plenty to do with traditional indexes," says Gary McDonald, director of marketing for State Street Global Advisors. Mr. McDonald said the company has looked closely at "enhanced" ETFs, but would rather focus on rounding out its traditional offerings in areas such as fixed income.
online.wsj.com |
