New PowerShares Are ETFs Of ETFs

May 20, 2008

The latest ETFs from PowerShares use other ETFs to construct portfolios that target different risk levels.

PowerShares once again broke new ground in the exchange-traded fund industry with the launch of the first ETFs of ETFs, the PowerShares Autonomic Global Asset Portfolios. The three funds were launched Tuesday on the American Stock Exchange and track indexes of ETFs designed by Boston-based advisory firm New Frontier Advisors (NFA).

The PowerShares Autonomic Growth NFA Global Asset Portfolio (AMEX: PTO), PowerShares Autonomic Balanced Growth NFA Global Asset Portfolio (AMEX: PAO) and PowerShares Autonomic Balanced NFA Global Asset Portfolio (AMEX: PCA) represent three different asset allocation strategies and risk levels, with differing amounts assigned to several different asset classes. The equity allocation encompasses domestic stocks, foreign stocks and real estate, while the fixed-income bucket covers fixed income, and commodities and currency.

The indexes are constructed to capture a certain risk level, and NFA uses its proprietary "Resampled Efficiency" optimization processes to construct an index of ETFs that will deliver maximum returns for the desired risk level.

PCA's assets are approximately 60% equity and 40% fixed income. Meanwhile, PAO is 75% equity and 25% fixed income, and PTO, the most growth-oriented of the three new ETFs, is 90% equity and just 10% fixed income. Each ETF has 27 holdings, and not surprisingly, many of those are PowerShares products. The underlying indexes are rebalanced on a quarterly schedule but can be rebalanced more often if market conditions cause the indexes to deviate from their targeted risk levels.

PCA's largest holding is the PowerShares Dynamic Europe Portfolio (AMEX: PEH), which represents 14.84%, followed by the iShares iBoxx Investment-Grade Corporate Bond Fund (NYSE Arca: LQD) at 8.05%, the PowerShares Dynamic Developed International Opportunities Portfolio (AMEX: PFA) at 7.19%, the iShares Lehman MBS Fixed-Rate Bond Fund (AMEX: MBB) at 6.50% and the SPDR Lehman International Treasury Bond ETF (AMEX: BWX) at 5.19%. The fund's underlying index has consistently outperformed the S&P 500 since 2003 and was down 3.76 for the first quarter versus a 9.44% decline for the S&P 500.

PAO's largest component is PFA at 14.69%, followed by PEH at 13.67%, the PowerShares Dynamic Large Cap Portfolio (AMEX: PJF) at 8.92%, the PowerShares Dynamic Asia Pacific Portfolio (AMEX: PUA) at 4.62% and LQD at 4.40%. Like PCA, PAO has steadily outperformed the S&P 500 on an annual basis; it was down just 5.62% for the first quarter.

PTO's largest holding is also PFA, with a 22.18% weighting. The remaining top five holdings include PJF at 13.03%, PEH at 7.78%, PUA at 4.62% and the Vanguard Emerging Markets ETF (AMEX: VWO) at 4.55%. As in the cases of the other two funds, PTO's index outperformed the S&P 500 every year since 2003, and PTO was down 7.87% for the first quarter.

Efficient Exposure? 

These aren't target date funds, so the risk level does not adjust itself along a glide path, but for someone who wants to target a specific risk level over a period of time, these funds could offer efficient exposure. On one level, the new ETFs could appeal to a lot of investors, such as those looking for easy diversification or a core holding. And should ETFs ever gain full acceptance in the 401(k) market, these funds could get a lot of attention.

On another level, they also could represent a brilliant marketing move for PowerShares, since priority is given to the other PowerShares ETFs when constructing the indexes. All but 10 of PAO's holdings are PowerShares funds, roughly 62% of the portfolio. And while 12 of PTO's holdings are not PowerShares funds, those ETFs represent less than 25% of PTO's total portfolio. Whenever investors buy shares of PAO, PTO or PCA, they will be driving assets into other PowerShares funds.

The one problem PowerShares may face is objections from advisors. By offering investors diversified portfolios via a single product, PowerShares could be seen as bypassing advisors, a group with which the firm has traditionally enjoyed a strong relationship. Although these are not lifecycle funds that automatically adjust their risk exposure over time, each of the three funds offers exposure to 27 different ETFs. That's a lot of money out of advisor pockets, assuming the advisor would arrive at a similar number of holdings. However, PowerShares most likely already consulted with its client base before rolling out these products.

All three funds charge an expense ratio of 0.25%, which is definitely on the lower end of the spectrum for ETFs. However, remember that expense ratio is applied on top of the expense ratios of the ETFs held by each fund.



You can read the prospectus for the PowerShares Autonomic Global Asset Portfolios here.

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