Alpha And Fees

September 06, 2007

I have just read the latest Hougan additions to the "impact ETFs" discussion. Again, I'll share some deep secrets about my views on alpha and fees (be patient).

I don't know if Matt numbered them #1 to #5 with #1 being best or the other way around (and he could figure out how to make Microsoft Word count down). I'm going to assume his #1 was his first one?the PowerShares Currency Harvest fund. Let me tell you, I love that fund, and it would have been on my list, except that (completely contrary to everything I say about stay the course) I was skittish about the current environment for carry trades, currency yield spreads and the like.

I went to a BGI media event (the one where they had Burton Malkiel come in and say Jack Bogle was just wrong about ETFs and then talk mostly about China) and Paul Mazzilli (central researcher at Morgan Stanley) singled out that fund-as-a-fad fund, a bad fund. And I couldn't BELIEVE it. I didn't have to say anything, because one of the other panelists stepped in to defend it. But carry trades and long short currency pairs have been an institutional staple for a long time...and really for retail, unless you're REALLY ambitious, until now, not at all an accessible strategy.

So kudos on including that one. And by the way, the carry trade environment has improved a bit even in the last couple weeks. And it's not like currency yield spreads don't tighten now and then...there's just compelling data that shows that over time, this strategy has really made hay.

DBC I talked about in my original, citing DJP as a more tax-efficient fund with a more recognized index. The tax issue, we're still working on with the IRS. And of course you've got the issuer risk, which is the price of perfect tracking.

The Vanguard funds of course look good. I might add their bonds in here (I DID actually). And that EM high-yield fund from WT I've talked about as well. The inverse funds definitely have their slot, but is it just for interday trading/hedging, or is there longer-range utility to these? I have seen virtually no discussion on this, but have seen some research that, particularly on the short side, makes me nervous about holding on to one of these for very long.  We need to look at them more intensively...and Rydex has a whole bunch of them coming out as well (if their lawyers let them launch).

Now it's time for me to bury some treasure deep inside the blog for those of you who are dedicated enough to read all the way down through my review of Matt's review. For the dedicated industry watchers, it does really look like things are beginning to shake out a bit in the ETF industry. The jury is still out on a few shops and some of the new ones coming in, but here's my redux of my earlier issuer handicap.

Since I wrote that, Claymore really seems to have emerged (cracking $1 billion) and has put together a strong dedicated team. Most of the rest of these seem the same. Most surprisingly to me, the Big 3 (BGI, SSgA and Vanguard) have ALL launched a LOT of very nice products in the first half of the year through the summer. And of course PowerShares continues to crank away. ProShares seems solid, and the question is, how much more juice will they get out of all these new launches. Rydex has a lot of great products and a nice asset base. Let’s see how they do under the new regime. First Trust?hard to tell. I want to see how these new Alphadexes do. XShares also has a lot of new things in the pipeline?including, most interestingly to me, the TD Waterhouse target dates. And among the smaller issuers and the new issuers coming down the line, it's watch-and-wait, for us...

And here's something additional on fees. My view is that generally speaking, fees have nothing to do with the cost of actually running or managing a fund...particularly not in the ETF business, but really not in the fund business generally. With active funds, I guess you can at least make the case that ongoing constant research has to be done (though it's still pretty much about hand over fist, judging by the ICI offices).

Heck, with an ETF, all you've got to do is come up with the clever idea to set the trigger points for your index, and then the computer tells you what's in the portfolio and you simply leverage the infrastructure of the rest of the's all incremental, and it's mostly margin. So it's more what the market will bear than what the fund costs to manage. I guess that's capitalism. And if the thing makes money, or you can sell it, more power to you. Ultimately, the investors will decide where their money will go.

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