'Claymore 11' Incident Isn't Black Friday For ETFs

February 03, 2008

Geez, Jim ... how can you separate sports and investing? As someone who lives in the heart of Moneyball country, the two go hand-in-hand.

But if you insist, let us get back to the more mundane indexing landscape.

The Claymore liquidation of 11 ETFs on Friday was a big yawner. Most of these funds are very young, have very little in assets ... and Claymore's giving investors more than two weeks' notice. How many assets do you think will be left in these ETFs by the time the plug's pulled? Doesn't seem like that big of a tax debacle, does it?

No doubt, more ETFs are bound to be closed going forward. (Can we ban the word 'shuttered' from this Web site's vocabulary?) But the real issue from an investor's perspective is crummy performance. Still, a lot of people are jumping on the "11" number and trying to make a bigger deal out of it than really necessary.

Maybe it's an issue for business-to-business wheeling and dealing. For investors, I just don't see what all of the hoopla's about at this point.

This isn't the start of anything ... it's the continuation of a young industry trying to find an equilibrium between giving people what they want and making a profit. It's easy to pick on individual players for calling it quits. But look at what Claymore did ... they took a hard look at a combination of weak asset levels and lousy relative performance.

How many open-end mutual funds are liquidated or merged a year? I can't tell you the exact figures, but a few years ago I did a story on just that topic and found that it's not an inconsequential total. At the same time, the number of new open-end mutual funds launching has peaked. It's certainly nowhere near the levels of new ETFs coming out these days.

(A bigger fear in 2008 might be a trend of more closed-end funds deciding to morph into ETFs).

In any case, there's little doubt that this liquidation should serve as a heads-up to investors. There's real danger in this wildly expanding market for people choosing to plunk down money on an ETF without fully understanding how its underlying index works.

Take a look at the now-infamous Claymore 11. Most cover specific broad asset classes, from small-cap value to large-cap core. How many ways are there to slice up the same corners of the efficient frontier as traditional, passive index-based ETFs?

As analysts and writers, it's going to become even more critical to ask what the qualifications and background are of those creating benchmarks for new ETFs. I remember a few years ago an energy ETF came out and I asked the indexer what his background was before his present line of work. He was a journalist with a small newspaper, part of a chain I had once worked at. I was astounded. As he explained the index, it became apparent that his "methodology" for picking stocks was based on his own personal analysis.

His "rules-based-methodology" was pretty subjective.

Yet, the big sponsors line up to strike deals as fast as anyone can come up with some of these alternative benchmarks. I think Rick Ferri's work with ETF strategy boxes is going to increasingly become important as a tool for investors to cut through the wasteland that ETFs are becoming.

This industry really needs a heavy dose of self-governance. The ICI has started the process, and we're going to be looking more closely at this effort.

But in the end, I've gotta believe we're in an environment of buyer-beware the farther off the beaten path you go with ETFs.

Does an industry roundtable sound in the cards, guys?

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