September 01, 2006

Exchange - Traded Notes

Barclays Bank PLC, a division of Barclays PLC, won approval from the Securities and Exchange Commission (SEC) to launch a new kind of security that straddles the line between structured debt and ETFs. Dubbed " i Path ETNs," the new products trade like ETFs but use a debt-based struct u re that changes the tax implications, risks and arbitrage opportunities on the funds.

So far, Barclays has rolled out three ETNs: one tied to the total return version of the Goldman Sachs Commodity Index (ticker: GSP), one tied to the total return version of the Dow Jones AIG Commodity Index (ticker: DJP) and one tied to the Goldman Sachs Oil Total Return Index (ticker: OIL). The funds trade on the NYSE.

In a traditional ETF, share holders own a stake in the underlying assets, and if you hold enough shares, you can (through an Authorized Participant) redeem those shares directly from the fund for the corresponding value of said assets.

That is decidedly not the case with the iPath ETNs. The iPath ETNs are debt instruments. When you buy an ETN, you are buying a senior debt note from Barclays PLC, where b y B a rclays promises to pay you the exact return of the underlying commodity index-minus an expense ratio of 75 basis points per year.

The primary functional difference between ETFs and ETNs lies in the different kinds of risk that investors take on when they buy the products. With ETFs, investors take on "tracking risk"-the risk that the underlying assets will not accurately track the intended benchmark. With ETNs, Barclays guarantees that the ETNs will track their benchmarks, so there is no tracking risk. Instead, investors take on "credit risk"-the risk that Barclays won't pay up on its promises.

There are other important differences that investors must consider. For instance, there is no guarantee that there will be a liquid market for the ETNs, although Barclays says it will engage in "limited trading" to support the notes. (Investors should keep a close eye on spreads.)

One further uncertainty for the notes involves their tax status. According to Barclays, "[t]he United States Federal income tax consequences of an investment in the iPa t h ETNs are uncertain." Barclays believes that investors will only pay capital gains taxes when they sell the funds, with no possibility for distributions in the interim. That would be quite attractive ... if it holds up at the IRS.

It's not clear how Barclays plans to separately market its ETNs and ETFs, particularly when they cover the same product. For instance, as we went to press, Barclays received approval for an ETF linked to the Goldman Sachs Commodities Index. It's not clear how Barclays will distinguish that product from the existing ETN linked to the same index.

Baker To SEC: Get Moving

Rep. Richard Baker (R- La.) has a message for the SEC: Get moving on ETFs, or the ETF industry will get moving overseas.

The blunt-speaking congress man, who chairs the Congressional Subcommittee on Capital Markets, Insurance and Government Sponsored Enterprises, has a history of prodding the SEC on competitive issues. He famously called Regulation NMS "the worst public policy I have seen in my nearly two decades in Congress."

In his latest move, Baker told the SEC that it needed to develop stand a rdized rules on approving ETFs, and to create a dedicated staff whose only focus is on the ETF industry.

Massive PowerShares Expansion

PowerShares Capital Management filed with the SEC for the right to launch 31 new ETFs, including a full line-up of RAFI-branded "fundamental indexing" ETFs, a host of Intellidex funds and a number of interesting stand-alone portfolios.

The RAFI funds are based on the "fundamental indexing" methodology of Rob Arnott's Research Affiliates (RAFI). PowerShares already sponsors one RAFI fund, the RAFI U.S. 1000 ETF (ticker: PRF), which debuted in December 2005 and has attracted more than $115 million in assets. The new funds include one U.S. small-/mid-cap ETF and nine sector-based funds.

The remaining 21 filings cover a wide range of ETFs tied to a number of different strategies. Among these, the India Tiger Portfolio may prove to be one of the more popular. The fund will track an equal-dollar-weighted index of Indian companies that trade on U.S. exchanges, and will likely be the first India-specific ETF on the U.S. market. A full listing of the funds is available at

One concern about the new ETFs is that they will charge 70 basis points in expenses, pus up the boundaries of expense ratios among ETFs.

Vanguard Embraces Its ETFs

Vanguard  has dropped the VIPERs brand name from its rapidly growing family of ETFs. The funds wil now be called, simpl "Vanguard ETFs" Th move impacts all 24 Vanguard ETFs, wh together hold more than $15.4 billion in assets. M see this move as a tacit a edgement by Vanguar that ETFs will play a critica role in the company's future .

Exemptive Relief

In related news, Vanguard received exemptive relief from the SEC permitting mutual funds to invest in Vanguard ETFs in excess of the limits outlined in section 12(d)(1) of the Investment Company Act of 1940. A number of ETF fund families have received this kind of exemption recently, which allows mutual funds to place more than 5 percent of their assets in a given ETF.

Pounds, And Pesos, And Krona: Oh My!

Following on the re markable success of its first currency ETF, the Euro Currency Trust (FXE), Rydex Investments launched six new Currency Shares ETFs:

• Currency Shares Australian Dollar Trust (FXA)
• Currency Shares British Pound Sterling Trust (FXB)
• Currency Shares Canadian Dollar Trust (FXC )
• Currency Shares Mexican Peso Trust (FXM)
• Currency Shares Swedish Krona Trust (FXS)
• Currency Shares Swiss Franc Trust (FXF)

The funds have a beautiful simplicity: They hold the given foreign currency as their sole asset, with the requisite number of pounds (or pesos or krona) deposited at the London branch of J.P. Morgan. The deposits earn interest income based on the home country funds rate. At launch, the peso paid the highest yield, at 6.43 percent, while the Swiss franc

Offered just 0.78 percent. All of the ETFs charge 40 basis points in annual expenses .

Better Bullion?

Van Eck Associates, an old-line, hard assets securities firm, joined the ETF revolution by launching the new Market Vectors-Gold Miners ETF (ticker: GDX) onto the American Stock Exchange (AMEX). GDX is designed to track the Amex Gold Miners Index, a 44-component, modified cap-weighted index of U.S.-list-ed gold mining companies.

With GDX trading alongside the wildly popular gold bullion ETFs, the question for investors is whether it is better to gain exposure to the physital metal or to gold mining compahe The arguments could easily fill this agazine. Generally speaking, gold mining shares are more volatile than gold bullion, often moving twice as much as the underlying metal. They also come with the corporate risks involved in owning any company, including executive asance, environmental litigation xposure and other issues. On the flip side, gold bullion is woefully ax-disadvantaged for wealthy tors: Gold bullion is classified as a ectible, "making it subject to a 28 cent tax from the IRS, whereas gold mining companies are classified as an investment" and subject to the 15 percent maximum long-term capital  gains tax.

SSgA Launches Six Sector Slivers

State Street Global Advisors (SSgA) unched six new ETFs onto the Amex in June, as it continued the aggressive expansion of its ETF lineup.

The funds include five SPDR-branded, subindustry ETFs tied to indexes from Standard and Poor's (S&P), and one ETF tied to the Keefe, Bruyette and Wood (KBW) Regional Banking Index. The funds are:

•  SPDR Metals & Mining ETF (XME)
•  SPDR Oil & Gas Equipment & Services ETF (XES)
•  SPDR Oil & Gas Exploration & Production ETF (XOP)
•  SPDR Pharmaceuticals ETF (XPH)
•  SPDR Retail ETF (XRT)
•  Street TRACKS KBW Regional Banking ETF (KRE)

SSgA, like other ETF providers, has moved aggressively into the subindustry space over the past eight months. In November 2005, SS g A launched three ETFs tied to KBW's Banking (ticker: KBE), Capital Markets (ticker:KCE) and Insurance (ticker: KIE) indexes. And according to recent filings, SSgA is planning SPDR- branded sector portfolios tied to ten additional industries, as well.

SSgA funds offer the lowest expense ratios of any subsector funds, at just 35 basis points. By contrast, PowerShares charges 60 basis points, while BGI saddles investors with fees of 48 basis points.

The subindustry space is clearly one area where the choice of index matters ... a lot. The SPDR- branded indexes, for instance, are equal-weighted indexes, offering markedly different exposure from the cap-weighted industry indexes tracked by BGI's iShare s .

First Trust Sectors

First Trust Advisors rolled out two new ETFs tied to the Internet and biotechnology sectors, respectively.

The First Trust Dow Jones Internet Index Fund (ticker: FDN) tracks the performance of the Dow Jones Internet Index, which includes the forty largest Internet companies in the U.S. The index includes 25 "Internet Services" companies and 15 "Internet Commerce" companies, and is market-cap-weighted with the usual free-float adjustments.

The First Trust Am ex Biotechnology Index Fund (ticker: FTB) tracks the performance of the AMEX Biotech Index, an equal-weighted index of twenty established biotech companies. The index has long been one the most closely followed barometers of the biotech sector, and is actively traded on the options market. It is better known by its ticker symbol, BTK.

Both ETFs charge 60 basis points.

Insider Sentiment Portfolio? Sabrient Stealth?

Claymore Advisors, traditionally a closed-end fund shop, has filed with the SEC for the right to launch five ETFs, including some of the more unusual funds to be proposed so far.

The most anticipated of the five funds is likely the BRIC ETF, featuring a portfolio of American Depository Receipts from companies in Brazil, Russia, India and China.

The other funds include the Claymore-Sabrient Insider Sentiment Portfolio, which chooses 50 stocks that have witnessed both strong corporate insider buying and recent Wall Street analyst upgrades. In a twist, this portfolio will be rebalanced "whenever market conditions warrant," a fact that seems to stray awfully close to active management.

A third fund is the Claymore-Sabrient Stealth Portfolio, which tracks a portfolio of 250 stocks that are "flying under the radar screen of Wall Street's analysts," but that have strong growth prospects. The other funds are the Zacks Sector Rotation Portfolio, following a value-based sector rotation strateg y, and the Zacks Yield Hog Portfolio, an index of 125-150 securities that are chosen based on high yields and good growth prospects. The funds will all list on the Amex. As of yet, there's no information on expense ratios.

PWC Earns Five Stars

After 36 months on the market, the PowerShares Dynamic Market Portfolio (ticker: PWC)-one of the two original PowerShares funds- was awarded the maximum of five stars from Morningstar.

Morningstar only rates funds with three years of performance data.

Countering Contango

The Deutsche Bank Commodities ETF (ticke r: DBC) has adopted a new policy designed to mitigate the impact of "contango" on share holder returns. DBC's new rules-based strategy will allow it to select the most favorable contract when it rolls over its futures contracts each month. If, for instance, the August aluminum contract is cheaper than the July contract, the fund will purchase the August contract.

"The result will tend to maximize the benefits of rolling in backward at-ed markets and minimize the loss f rom rolling in contangoed markets, " Deutsche Bank says in a statement.

DBC Also Lowers Fees ... Again!

For the second time this year, the team behind DBC has slashed the fees it charges investors.

When DBC launched in February, it charged a gaudy 1.9 percent - somewhat of a disappointment to commodities investors. Just one month later, however, the fund slashed fees by 60 basis points, bringing the "all-in" expense ratio (including bro kerage fees, operating expenses, etc.) down to 1.3 percent. Deutsche Bank said at the time that it had essentially overestimated the costs of running the fund.

Now they've done it again, cutting fees a further 43 basis points to bring the "all-in" fee down to just 87 bps. The cuts include a 20 bps reduction in the management fee (from 95 bps to 75 bps), an 8 bps reduction in the estimated brokerage expense, and the assumption of 10 bps in o rganizational/offering fees and 5 bps in administrative fees.

What's wonderful about the fee reduction is that it is happening for all the right reasons: DBC has now attracted more than $600 million in assets, and the fund is passing along the economies of scale to share holders. That's what should happen ... but so rarely does in the world of ETFs.

DB Files For Seven More

In related news, Deutsche Bank has filed with the SEC for the right to launch an additional seven commodities-based ETFs. The new funds will focus on individual "sectors" within the commodities space, including Energ y, Oil, Precious Metals, Gold, Silver, Base Metals and Agriculture. In each case, the funds will gain exposure using futures contracts and will track "optimum yield" indexes from Deutsche Bank, meaning they will have some flexibility in the timing their "rolls" maximize returns.

The Little ETF That Can Beat The Market

First Trust Portfolios launched a new ETF onto the American Stock E xchange (Amex) that puts a new spin on the idea of value investing. The First Trust DB Strategic Va l u e Fund (ticker: FDV) attempts to look beyond the cover story of reported financial metrics and suss out the true, underlying value in the market.

The fund will track something called the Deutsche Bank CROCIUS + Index, which capture s 40 stocks f rom among the 251 largest names in the S&P 500 Index. It chooses stocks with the "lowest positive CROCI Economic Price Earnings Ratio"-which is a fancy way of saying stocks with high operating margins and strong returns on capital.

The methodology uses various assumptions to make reported financial metrics more comparable across sectors and markets. The 40 companies are assigned equal weights in the index.

The result is a "value-based" ETF that reflects firms' underlying pro fitability ... a factor that historically has had a strong tie to performance. Over the past ten years, for instance, the index has delivered returns of 17.94 percent per year, compared to just 9.16 percent for the S&P 500 Value Index.

The fund reminds many of Gotham Capital principal Joel Greenberg's best-selling book, The Little Book That Beats The Marke t . That book also emphasizes the importance of picking stocks that earn more than their cost of capital, and promises backtested returns of over 30 percent per annum.

The ETF charges 65 basis points in annual expenses.

First India ETF Trades

BGI launched the first India fund to trade outside that country's borders onto the Singapore exchange. The new iShares tracks MSCI's India index, which covers 85 percent of the f ree float-adjusted market cap of each industry group in the Indian market.

Borsa Italiana Trades Commodity ETFs

The first ETF ever to track the venerable Reuters/Jefferies CRB launched onto the Italian Stock Exchange in June, with Ly xor as the sponsor. In related news, EasyETF debuted its own commodities ETF in Europe, with a new fund tracking an 18 compoment, non-energy subindex of the Goldman Sachs Commodity Index.

Stockholm To Trade Fundamental European ETF

Stockholm-based XACT Fonder AB signed a license agreement to use FTSE's new fundamentally weighted European Index as the basis of a new ETF. The ETF, which is awaiting approval by the Finansinspektionen (the Swedish Financial Supervisory Authority), will be the first to use a fundamental weighting scheme in the Nordic region.

Canadian ETF Trades In Mexico

As international interest in Canadian equities continues to surge, foreign investors are snapping up shares of Canada's natural resource companies. Capitalizing on the trend, BGI launched its Canadian-based iShares S&P/TSX 60 on the Mexican Bolsa.

The Russians Enter Paris

With Russian stocks trading up nearly 30 percent on the year, Lyxor AM launched a new Russian equities ETF onto the Paris Stock Exchange. The ETF tracks the Dow Jones RusIndex Titans 10 Index, a measure of the ten largest Russian stocks on the market. According to Dow Jones, the new ETF is the "first tradeable product focused on Russian equities." More than 50 percent of the index is currently tied to energy-related companies.

Smartshares Adds An ETF

Smartshares, the innovative ETF outfit in New Zealand that allows shareholders to buy ETFs without a commission, has acquired the rights to the Tortis Ozzy ETF, a fund linked to the large-cap Australian S&P/AST 20 Index. It is the fifth Smartshares ETF.

Jim Rogers Is Back... In Europe

ABN Amro became the newest company to enter the ETF market when it launched its first-ever ETF onto the Deutsche Borse's XTF trading platform. The new "Marke t Access Jim Rogers Commodity Index Fund" (ISIN: LU0249326488) is based on the commodities index created by the Wall Street investing legend of the same name. The index tracks a hugely diversified swathe of commodities ranging from crude oil to live cows, platinum and adzu-ki beans.

Lyxor Launches

In related news, Ly xor Asset Management launched an an al six ETFs onto the the Borse's XTF platform. The new products include five fix ETFs-four covering EuroMTS bonds (one- to three-year maturity, three- to five-year maturity ten- to 15-year maturity and the global index), one EuroM TS Linked ETF and one  ETF tracking the 16 European countries covered by the MSCI Europe Index.

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