Revolution or Gadget?

May 24, 2007

Chalk one up for ET...somethings I guess: ETN's - in this case (BWV). Lower cost exchange-traded index products have opened up another space to low cost index investors. This time it's the buy-write strategy.

When I first saw the introduction of iPath ETNs, I was befuddled, and got the feeling that BGI had introduced the products (right around the same time as the iShares GSCI (GSP) – now S&P GSCI - came out) and DJ AIG (DJP) as a side effect of working the regulatory regime from two directions to see what came out first.Subsequently they’ve added the GSCI Oil (OIL) iPath ETNs in the commodities space.

Both the iShares and iPath commodities basket funds were beaten to the market (the exchange traded commodities basket market, that is) by the Deutsche Bank Commodities Index Tracking Fund (DBC). It seemed at that time that the GSCI iPath ETN might become an orphan – but it’s done quite well – and its kin, the Dow Jones AIG ETN (DJP) has blown the others out of the water – as I discover further down in this blog.

It’s a wild and woolly space, the exchange-traded funds market, and what looks certain today could be far from certain tomorrow. I do think that it’s possible that ETNs could completely revolutionize the space, providing on-the-money tracking and much more importantly if it comes out this way, enormous tax benefits, particularly for the types of products they are launching, designed to track the performance of asset classes that traditionally can only be accessed through the use of structures that have a tendency to spew out enormous amounts of highly taxable income.

And – less discussed – only a few major players really have the ability to issue this sort of product. So line up those alliances and get your note-writing gear in place.We could be entering a whole new era…one with more reasonable prices than the closed-end products in some of these spaces – and with perfect tracking and less income tax.

We definitely have our eye one developments in the space…and there is a lot going on behind the scenes in some of the more esoteric asset classes. I’ve been waiting for a long time for a buy write index ETF or ETF-like product to come out, and now we have it. Next up, munis, more international style and a 130/30 fund.

Lets take a pause and look at "benefits of first to markets" scorecard:

  • The S&P GSCI iPath was launched on June 6, 2006 and has $163 million
  • The Dow Jones AIG iPath was also launched on June 6, 2006 and has…whaaaaaa? $1.6 BILLION in assets. And it trades a couple hundred thousand shares a day.
  • The S&P GSCI iShare was launched on July 10, 2006 and now has net assets of $216 million (OIL the S&P GSCI Oil iPath launched on December 19th, 2006 and has $350 million in assets – and according to the iPath site trades 650,000 shares a day!)
  • The Deutsche Bank Commodities Index ETF was launched on February 3, 2006 and has assets of $875 million (BTW, the currency harvest fund (DBV) launched on September 18, 2006 has $380 million.

So that’s kind of funny – the DJAIG iPath ETN sort of blew my theory out of the water…to be honest I had no idea it had that kind of assets – and I’m familiar with the space since we manage the www.hardassetsinvestor.com Web site, which is all about commodities.

It’s always fun to pour through the data – and the above is extremely interesting.It makes you wonder exactly what’s going on here. Who is trading all of those OIL shares. Hedge funds? (always a good suspect) Institutional players who might normally trade the futures? Inquiries must be made. But I guess it’s not too surprising that the broad commodities baskets look a bit more buy and hold, and the Oil is trading. At least SOMETHING is trading in the space. A quick look to the data – USO (the US Oil ETF) which I knew had nearly a billion in assets – is trading 2.95 million shares a day. Very interesting…I sense an article here.

Which brings us back around to the iPath ETNs. Time will tell how they shift the market. But the tax issues, for example are just shaking out now. They could completely shift the landscape in unexpected ways, much the way ETFs did. The tax benefits of the creation and redemption structure only dawned upon the developers of ETFs late in the process…as told to me by beloved Nate Most, who developed the first ETFs at the AMEX. We miss you Nate…

And just by the way, the iPath CBOE S&P 500 BuyWrite Index ETN held $15 million at the end of day one, with volume of 3,600 and an even 300,000 shares outstanding. Next chapter: Beyond My Seed - A Story of Income Generation.

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