Around The World Of ETFs

June 18, 2007

ETFs Approach $500 Billion

New research from Morgan Stanley found that inflows into U.S.-listed ETFs topped $11.6 billion in the first three months of 2007, bringing total ETF assets in the U.S. to approximately $480 billion. That actually represents a significant slowdown in asset growth, as it calculates out to just 10 percent annualized growth. In comparison, the industry grew 40 percent in 2006.

The slowdown raises questions about the hype surrounding the ETF space. Venture capital funds and industry boosters have been saying that ETF assets will hit $2 trillion by 2010. To do that, however, asset growth must run at a 60 percent annualized clip for the next four years. There are ways the industry could do that—if it moves into the 401(k) market in a serious way; if all the work companies have been doing to market to financial advisors starts to bear fruit; etc.—but right now, that $2 trillion number is a long way off.

One area of the market is growing fast, however: listings. Morgan Stanley said 95 new ETFs listed in the first quarter of the year, bringing the total number of ETFs on the market to 469. Two ETF providers (BGI and State Street Global Advisors) together had nearly 80 percent of all assets, with the 15 other providers fighting over the crumbs.

Competition For Bond ETFs

Vanguard became just the second company to offer fixed-income ETFs in the U.S., as it launched ETF shares tied to four of its popular bond funds: Short-Term Bond (AMEX: BSV), Intermediate-Term Bond (AMEX: BIV), Long-Term Bond (AMEX: BLV) and Total Bond Market (AMEX: BND). The new ETFs charge just 0.11% in expenses, which compares well with the 0.15%-0.20% fee BGI charges for competing ETFs.

Vanguard Plans Active Bond ETF

Vanguard has filed initial papers with the SEC for the right to launch an actively managed fixed-income ETF. The new ETF will be a separate share class of the actively managed Vanguard Inflation-Protected Securities Fund (VIPSX).

Vanguard decided to file the ETF because it wanted to expand its fixed-income ETF lineup into Treasury Inflation-Protected Securities, or TIPS. The active component is a fallout of the fact that Vanguard does not offer a TIPS index fund. The new Vanguard TIPS ETF, if approved, will compete with the iShares Lehman TIPS Bond ETF (NYSE: TIP). The two offer substantially similar exposure, in part because they draw from a limited universe of possibilities: There are currently exactly 21 TIPS securities in existence.

High Yield, High Prices

BGI continued to expand its fixed-income ETF offerings this spring, launching a new junk bond ETF onto the AMEX. The iShares iBoxx $ High Yield Corporate Bond Fund (AMEX: HYG) tracks a focused index of 50 (+/-) high-yield corporate credits. BGI says the fund will be generally representative of the high-yield space, which Reuters says currently yields about 2.5 percent more than Treasuries.

Notes On The Notes

Barclays Bank PLC expanded its lineup of exchange-traded notes (ETNs) on May 9 with the launch of three currency-focused products:


In each case, the notes provide exposure to the named currency pair: euros, British pounds and Japanese yen, respectively, against the U.S. dollar.

Investors will be quick to compare these ETNs to the popular CurrencyShares ETFs as, for each iPath ETN, there is a corresponding CurrencyShares ETF:

• CurrencyShares Euro Currency Trust (NYSE: FXE)
• CurrencyShares British Pound Sterling Trust (NYSE: FXB)
• CurrencyShares Japanese Yen Trust (NYSE: FXY)

The two products provide similar exposure, but come with very important differences—particularly on the tax and structure sides— which merit close examination.

ETNs are senior, unsubordinated debt from Barclays Bank PLC. Unlike ETFs, the notes do not represent a share of assets; they are a promise from Barclays to pay you an amount reflecting any change in the underlying index. CurrencyShares, in contrast, own the actual asset. When you buy the CurrencyShares Euro Trust (NYSE: FXE), for instance, you buy a share in a bunch of euros sitting in a bank in London.

The key selling point of the iPath ETNs is that they may be significantly more tax-efficient than the CurrencyShares. For one, the ETNs do not pay dividends—any interest income is incorporated into the price of the note. In contrast, the CurrencyShares pay monthly dividends that are subject to taxation as ordinary income.

More importantly, the notes appear to have an advantage when it comes to long-term gains as well. Barclays has received an opinion that it is "reasonable" to account for its ETNs as pre-paid contracts with respect to their indexes. If that opinion holds, noteholders would not have to pay any taxes until they sold or redeemed the notes; even then, gains would be subject to long-term capital gains tax rates, which max out at 15 percent. In contrast, any and all gains on CurrencyShares ETFs are subject to ordinary income taxes, which top out at 35 percent.

It's A Gas, Naturally

Victoria Bay Asset Management, the group behind the $850 million US Oil Fund (AMEX: USO), became the first company to launch a futures-based ETF tied to the price of natural gas. The United States Natural Gas Fund began trading on the AMEX on April 18 under the ticker symbol UNG.

UNG, like other futures-based ETFs, will track the price of natural gas futures, and not the spot price of natural gas. Those two can differ significantly due to interest income and what's known as "roll yield," which is an important part of commodity returns. The "spot price" you hear about on the nightly news is not the price that UNG (or other futures-based ETFs) will trade at. The roll yield is the gain/loss that comes each time the ETF must sell an expiring futures contract and replace it with a new one.

Unfortunately, the natural gas market is currently in what's called "contango," meaning that later-dated futures are more expensive than the spot price. Oil investors can sympathize—oil has been and continues to be stuck in a vicious contango, which has hurt investor returns even as the price of oil has gone up.

In other news ... Victoria Bay filed new papers with the SEC for the right to expand its energy-focused ETF empire into heating oil and gasoline. The United States Heating Oil Fund will track the price of No. 2 heating oil futures, while the United States Gasoline Fund will track the price of so-called RBOB gasoline futures.

Small International Gets Big

State Street Global Advisors (SSgA) launched two new ETFs on the AMEX in April, including an international small-cap fund.

The SDPR S&P International Small Cap ETF (AMEX: GWX) will focus on companies in developed markets with market capitalizations below $2 billion.

The SPDR S&P World ex-US ETF (AMEX: GWL) will track an index of 5,000-plus companies from developed markets outside the U.S., including Canada.

Although GWL is a nice addition to SSgA's fund family, the real winner in the launch is the small-cap fund. Investors have become increasingly interested in small-cap international investing as they have become disenchanted with the vanishing correlation benefits formerly associated with large-cap international exposure.

An Alternative Energy Alternative

Van Eck has joined the race to capitalize on growing interest in the alternative energy space. The company launched the Market Vectors–Global Alternative Energy ETF (NYSE: GEX) on the NYSE on May 9. It is Van Eck's sixth ETF.

The new ETF tracks the performance of the Ardour Global Alternative Energy Index (Extra Liquid), a benchmark of 30 companies that derive at least half of their revenues from alternative energy. The fund has a global tilt: Currently, Europe represents 47.1 percent of the fund, the U.S. represents 41.8 percent of the fund, and China and Japan represent the remainder (11.1 percent).

GEX enters a crowded market, with four established competitors in the field.


The new Market Vectors-Russia ETF from Van Eck Global, which recently listed on the NYSE under the ticker symbol RSX, is the first ETF to focus on Russia, one of the best-performing markets over the past five years. The new fund tracks the performance of the DAXglobal Russia+ Index, a modified market-cap-weighted index of 30 publicly traded Russian stocks. The fund is dominated by energy exposure: In fact, RSX can be largely understood as an equity-based commodities play, as the fund is predominantly focused on commodity-producing companies. The index has a very low correlation of just 0.38 to the S&P 500 Index, which tracks large-cap U.S. stocks. In an era where low correlations are hard to find, that figure might be very appealing to investors.

Sector REITs Make Sense

BGI launched five new iShares REIT ETFs onto the NYSE Arca Exchange on May 4. The funds offer U.S. investors the ability to slice and dice the U.S. REIT marketplace into different "sectors."

The funds and tickers are:

• iShares FTSE NAREIT Residential (NYSE: REZ)
• iShares FTSE NAREIT Industrial/Office (NYSE: FIO)
• iShares FTSE NAREIT Retail (NYSE: RTL)
• iShares FTSE NAREIT Mortgage REIT (NYSE: REM)
• iShares FTSE NAREIT Real Estate 50 (NYSE: FTY)

Investors can use the different funds to fine-tune exposure or to try to "time" the REIT market. It may make sense in the REIT market, as the different underlying sector indexes perform very differently. Recently, for instance, the market for corporate office space has been very strong in the U.S, while the U.S. residential market has been crumbling.

Learning The Alphadex

Fourteen years after the first ETF hit the market, the industry celebrated a milestone on May 10 when the 500th ETF started trading. And not just the 500th ... the industry roared past the 500 mark, to 515, as 17 new ETFs from First Trust launched on the AMEX. Sixteen of those funds make up First Trust's new "AlphaDEX" family of ETFs, which use quantitative strategies in an attempt to beat the market. They are:

AlphaDEX Style Funds

• First Trust Large Cap Core AlphaDEX Fund (AMEX: FEX)
• First Trust Mid Cap Core AlphaDEX Fund (AMEX: FNX)
• First Trust Small Cap Core AlphaDEX Fund (AMEX: FYX)
• First Trust Large Cap Growth Opportunities AlphaDEX Fund (AMEX: FTC)
• First Trust Large Cap Value Opportunities AlphaDEX Fund (AMEX: FTA)
• First Trust Multi Cap Growth AlphaDEX Fund (AMEX: FAD)
• First Trust Multi Cap Value AlphaDEX Fund (AMEX: FAB)

AlphaDEX Sector Funds

• First Trust Consumer Discretionary AlphaDEX Fund (AMEX: FXD)
• First Trust Consumer Staples AlphaDEX Fund (AMEX: FXG)
• First Trust Energy AlphaDEX Fund (AMEX: FXN)
• First Trust Financials AlphaDEX Fund (AMEX: FXO)
• First Trust Health Care AlphaDEX Fund (AMEX: FXH)
• First Trust Industrials/Producer Durables AlphaDEX Fund (AMEX: FXR)
• First Trust Materials AlphaDEX Fund (AMEX: FXZ)
• First Trust Technology AlphaDEX Fund (AMEX: FXL)
• First Trust Utilities AlphaDEX Fund (AMEX: FXU)

The seventeenth fund launched that day was the First Trust S&P REIT Index Fund (AMEX: FRI), a broad-based REIT fund that tracks the S&P REIT Composite Index.

The AlphaDEX ETFs are the latest in the line of quantitative, "beat the market" ETFs. Not surprisingly, the backtested results look good. For instance, the First Trust Consumer Discretionary AlphaDEX has trounced the Russell 1000 Consumer Discretionary and Services Index, delivering 10-year compounded returns of 14.78 percent, compared to just 6.80 percent for the Russell index. Of course, the proof will lie in the real-time performance. So far, advisors have been slow to pick up on these "enhanced index ETFs," waiting for the funds to have three-plus years of real-time results before believing the hype.

Three More For First Trust

Just one day after launching its AlphaDex products, First Trust rolled out three new specialty ETFs on the NYSE Arca Exchange:

The First Trust ISE-Revere Natural Gas Index Fund (AMEX: FCG) tracks an equal-weighted index of 30 companies that derive at least half their revenues from the natural gas market.

The First Trust ISE Water Index Fund (AMEX: FIW) tracks a market capitalization-weighted index of 36 companies working in the potable and wastewater industries.

The First Trust ISE Chindia Index Fund (AMEX: FNI) offers balanced exposure to China and India, holding the 25 most highly liquid stocks in each country.

Which Water Is Best?

Water has emerged as the new "new" thing in investing. People do the math on limited water resources and creeping pollution and they see dollar signs.

ETF developers rolled out two new water funds recently: the First Trust ISE Water Index Fund (AMEX: FIW) and Claymore S&P Global Water Index ETF (AMEX: CGW). Those new funds join the PowerShares Water Resources Portfolio (AMEX: PHO), which launched in December 2005 and has pulled in over $1.6 billion in assets.

All three funds provide diversified exposure to the water industry, but with important differences. The most obvious is geography: The First Trust (FIW) and PowerShares (PHO) funds are U.S.-focused funds, while the Claymore (CGW) fund has a major global tilt. The First Trust (FIW) and PowerShares (PHO) funds have a good deal of overlap: 29 of the 36 components in the PowerShares fund also appear in the First Trust fund.

CDS ETFs in Europe

Two of the biggest buzz generators in the field of investing—ETFs and credit derivatives—have finally converged. Not one, but two European firms announced licensing deals to manage ETFs based on the same three iTraxx indexes this month.

EasyETF and Deutsche Bank both plan to launch ETFs based on the iTraxx Europe, iTraxx Europe HiVol and iTraxx Europe Crossover indexes. The iTraxx index family is one of three index families maintained by the International Index Company, a consortium started in 2001 of Deutsche Bank and 10 of the world's largest financial institutions. Deutsche Bank plans to launch its credit-derivative ETFs in June on its db x-trackers ETF platform, and later on several European exchanges.

Precious Metals ETFs

Platinum bulls have been gabbing about the prospects for a platinum ETF for years. The idea had everyone excited because the world's platinum markets are very tight and new investment demand from an ETF could push prices up. A rumor in November 2006 that BGI was about to file an ETF pushed prices up 27 percent in two trading sessions.

ETF Securities, the commodity ETF leader in Europe, rolled out new physical ETFs tied to platinum, palladium, silver, gold and a combined basket of those four metals.

The funds launched on the London Stock Exchange (LSE) and are:

• ETFS Physical Platinum (LSE: PHPT)
• ETFS Physical Palladium (LSE: PHPD)
• ETFS Physical Silver (LSE: PHAG)
• ETFS Physical Gold (LSE: PHAU)
• ETFS Physical PM Basket (LSE: PHPM)

This may be a case where the more-popular metals make less-popular ETFs. The gold ETF will be the second gold bullion ETF to trade in London, joining the Gold Bullion (GBS) fund from the World Gold Council. The silver ETF is likely to be more popular, as it will be the first silver bullion ETF on the market in London. But the real story will certainly be the platinum ETF, given the high levels of anticipation surrounding its launch. (The palladium ETF is likely to be less popular, as there is plenty of palladium and prices have trailed other metals.)

Big players are watching: Anglo Platinum, which accounts for 40 percent of all platinum production worldwide, said earlier that it would not supply metal to a planned platinum ETF in Switzerland. Anglo said that a platinum ETF takes physical metal away from the market, which pushes up prices for users.

Producers currently sell very little metal into the spot market, so things may look worse than they appear; as demand rises, supply to that market may well increase. But the world has been operating on a platinum deficit for the past eight years, and only 7 million ounces of platinum are mined each year. With prices at $1,300/ounce, that's about $9 billion worth of new platinum worldwide.

DJ Islamic Titans

The Swiss Exchange began trading the first ETF in Western Europe to offer exposure to Shariah-compliant companies at the end of January. Managed by BNP Paribas Asset Management, the DJ Islamic Titans 100 tracks the Dow Jones Islamic Titans 100 index, a blue-chip index tracking the top 100 global companies complying with Islamic investment guidelines.

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