Analyst Sees New Markets Opening For ETF Investors

Heather Bell
July 31, 2008

Highly regarded Wachovia researcher Mariana Bush assesses where ETFs and ETNs are heading and who'll be buying them.

Mariana Bush is widely regarded as one of the most influential voices in the exchange-traded funds industry.

A senior analyst with Wachovia Securities, she covers closed-end funds and exchange-traded funds for the brokerage firm. Bush has been quoted in leading publications such as Barron's, Business Week, Forbes, Money, and The Wall Street Journal. She is a chartered financial analyst.

Recently, IndexUniverse Assistant Editor Heather Bell caught up with Bush to get her latest take on ETFs and where the market's heading.

ETFR: Do you think we're going to see a lot of new ETF issuers?

Bush: There will probably be new index providers and new ETF providers here and there, but I think it is very competitive to get in. It's not like ETF providers are getting huge expense ratios and can afford to just take it easy. You have to be extremely competitive and I think the market favors the ones who are already there ... [I]f you don't have older, big funds out there [to subsidize your new products], you can't survive for too long.

ETFR: Are ETFs still growing?

Bush: I think they will continue to grow. If they have slowed down a bit, I would say it's probably market related. I think flows will just simply continue to go into ETFs because people will continue to prefer ETFs over mutual funds. I get calls from people telling me they are moving into ETFs, away from mutual funds. I am still surprised when I talk to people-fairly financially knowledgeable individuals-and they don't know about exchange-traded funds.

ETFR: ETFs seem to be delving into new asset classes such as commodities, muni bonds, buywrite strategies, etc. Do you think these funds make sense?

Bush: I think they do, because they do give us access to these asset classes that are not easily accessible. On the other hand, how many more dividend-focused ETFs do we really need? It's hard for me to keep track of how many dividend-focused funds there are. My feeling is, at this point, we already have plenty.

Just look at the financial ETFs. We don't only have the broad financials, but we have the industry financials and the sub-industry financials; even with REITs we have a bunch of sub-sub-sub indices, which is nice for those people that do want that fine tuning, but in other areas we already have plenty. They have to go into asset classes where we don't have exposure yet, and that's why they have gone into commodities, currencies, and strategies (such as 130/30, for example.)

ETFR: What areas do you think will be covered next?

Bush: Believe me, they [the newcomers] are much more creative than I am or can ever be, because they always come up with something new. But I can think of a few areas where we don't have exposure yet.

Corporate loans is an area where we don't have a single exchange-traded tracking product -- I include funds and ETNs, and grantor trusts. We already have some emerging market debt ETFs, but I don't believe we have ones denominated in local currency. I do see that in the closed-end fund format, and I'm sure there are some open-end funds in local currency, but not in ETFs.

A few other strategies might evolve in the future, as opposed to just exposure to asset classes. There are many more quasi-active strategies than one may initially think. Some existing ETFs track them, but I have a feeling that they can do more.

Hedge fund-like ETFs is an area we have not seen yet, a possible new space for ETF providers to enter. Another area is currency/commodity. As far as I know, there is only one currency ETF that tracks an index following a strategy, not just exposure, and that's DBV, which is a carry trade strategy. It goes long, three of the G10 highest yielding currencies and short, three of the lowest yielding currencies. So I'm sure you could do that maybe with commodities, addressing the contango/backwardation issues for instance.

I'm sure that those that do manage futures are very familiar with those strategies and could think of eventually doing something like that.

ETFR: Do you think actively managed ETFs will be successful?

Bush: I think it depends on a few things. Number one, it depends on what you compare it to. If you compare an actively managed ETF to an actively managed open-end fund, yes I do think there are advantages. However, one of the main reasons I would say that a lot of people moved -- and continue to move -- out of actively managed open-end funds into index funds is because managers don't tend to consistently outperform the indices long term.

Part of the reason is probably because of expenses. Actively managed open-end funds tend to charge more, and it burdens the performance of the fund.

I'm not sure a lot of people would move from ETFs to actively managed ETFs, but I can see people moving from actively managed open-end funds into actively managed ETFs. I think it will just take time. If these managers truly outperform, I think that they will be gathering assets. But if they don't, then what's the point?

ETFR: What do you think about ETNs?

Bush: The biggest advantage that I see in ETNs is that they provide more flexibility than ETFs in terms of what they can track or what they can provide exposure to. Obviously, you also have the credit risk of the issuer, so if you can avoid that, I'd rather have an exchange-traded fund. But if it's an asset class or a strategy that I can't access through an ETF, I think ETNs provide a very interesting instrument.

There has been some talk about the tax benefit of ETNs. I wouldn't buy them for that. I would be interested in an exchange-traded note because it gives me access to an asset class or a strategy that I can not access any other way.

ETFR: How should an investor choose between two very similar funds, like SPY and IVV?

Bush: There are very, very few exchange-traded tracking products that actually track the same index. I can think of maybe three or four such pairs. In the case of SPY and IVV, they track the same index and they have slight differences, such as how they handle dividends. In that case, investors may emphasize the liquidity difference between them..

Another great example is VWO, which is the Vanguard Emerging Market and EEM, which is the iShares Emerging Market. At the very beginning when VWO came out, they both tracked very similar indices, but not exactly the same index. There were a few differences in the country breakdown. Obviously, if those countries did really well or really poorly then that's where you have your difference in performance. As long as there are some differences in the underlying indices, I would pay attention to that more than expenses, because what I have noticed is that the differences in performance are usually much greater than the difference in expenses.

Now, when we have funds tracking the same index [which VWO and EEM do now], I will want to look at expenses. In that particular case, you do have a very big difference in expenses. The expenses for the Vanguard are less than half the expenses of the iShares. Liquidity would be another factor to consider.

Most comparable funds are really tracking different indices. They may appear to be similar but one may have much larger-cap stocks than the other one, one may have a much higher weight in a sub-industry than another one. We prefer to compare the exposure of the indexes. I think that's going to make, as I said before, a bigger difference in performance versus a difference in expenses.

ETFR: How important are spreads and liquidity?

Bush: Obviously, it's important for investors who want to go in and out more frequently. But not only for them. You do want to keep track of some of those spreads. In many cases, they're really small, but with smaller caps or more unusual asset classes, the spreads will be wider.


Massive inflows into U.S. equity funds on Monday, Dec. 22, propelled total ETF assets to a new record.

'SPY' raked in more than $12 billion Monday, Dec. 22, pacing State Street's issuer-leading inflows on the day, as total U.S.-listed ETF assets jumped to $2.005 trillion.


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