Boom in ETFs seems to have ended

The boom in exchange traded funds appears to have come to an end. As of June 30, there were 698 ETFs in the United States with assets totaling approximately $575 billion, down $33 billion, or 5.4%, since the beginning of the year, according to State Street Global Advisors of Boston. The pace of product introductions also has slowed. In the first half of 2008, 87 new ETFs were launched, compared with 167 ETFs introduced during the comparable period in 2007, according to SSgA. The first two quarters of 2008 were also marked by a spike in ETF closings, as 11 ETFs from Claymore Securities Inc. of Lisle, Ill., and five ETFs from Ameristock Corp. of Moraga, Calif., were liquidated as a result of slow asset growth, according to SSgA. But industry insiders said they believe that the slowdown is little more than a bump in the road, attributable more to sour markets than ETFs themselves. "The economic environment has as much to do with it as anything," said James Ross, senior managing director of SSgA. ETF providers are planning for new products as if nothing has changed. As of Aug. 7, at least 538 ETFs and exchange traded notes — close cousins to ETFs — were in registration, according to IndexUniverse.com of New York. Of those, actively managed ETFs are generating the most buzz. Transparency issues have been holding up their development. The Securities and Exchange Commission insists that ETFs provide investors with transparency equivalent to that of stocks. While that isn't an issue for ETFs that follow an index, active managers are leery of telegraphing their moves out of fear that arbitrageurs will jump in front of their trades and wreak havoc on stocks in which they are interested.
The Bear Stearns Cos. Inc. of New York was the first to launch an actively managed ETF of any type this year when in March it unveiled the Bear Stearns Current Yield Fund, which aims to use active strategies to deliver superior yields to the average money market account. But Invesco PowerShares Capital Management LLC of Wheaton, Ill., took the concept of active management to the next level. It became the first to launch three actively managed equity ETFs in April. Such ETFs have the power to transform the industry, said Christian Magoon, president of Claymore Securities and head of its ETF group. "Look at mutual fund assets," he said. There are more assets in actively managed mutual funds than in index funds, Mr. Magoon said. "It points to people over time wanting to implement more-sophisticated investment strategies," he said. Not surprisingly, Claymore has filed two letters with the SEC seeking exceptive relief — permission to go forward and file — for actively managed ETFs it hopes to bring to market. Of course, Claymore is a relatively small player in the ETF market and trying to make a name for itself. The top three ETF managers — Barclays Global Investors of San Francisco, SSgA and The Vanguard Group Inc. of Malvern, Pa. — collectively control more than 80% of the assets in U.S. ETFs. They have been resistant to actively managed ETFs, but that is changing. SSgA plans to launch actively managed target date ETFs. Vanguard plans to offer four actively managed ETFs. Three would invest in Treasuries, and the fourth would invest in Treasury inflation protected securities. And Barclays — the largest ETF manager, with $296.95 billion in assets spread over 163 ETFs — is preparing to offer actively managed ETFs. "I think you will see active product from us," said Mike Latham, chief executive at Barclays Global Investors. "We are looking at a lot of different actively managed solutions." Some financial advisers, however, said they aren't thrilled with the prospect of such ETFs. Most advisers that use ETFs do so because it gives them low cost exposure to an index of securities, said Richard Romey, president of ETF Portfolio Solutions Inc., an Overland Park, Kan.-based advisory firm with $40 million in assets. That gives the adviser the ability to add value, because it's the adviser, not a fund manager, that provides the asset management function via asset allocation, he said. "Re-balancing is a form of active management that can be very effective," Mr. Romey said. It's not as if actively managed mutual funds have done so well, according to some market watchers. It's a point John Bogle, founder of Vanguard, has made repeatedly over the years. The Standard & Poor's 500 stock index outperformed 58% of comparable actively managed mutual funds from 1968 to 2006, he stated in "The Little Book of Common Sense Investment: The Only Way to Guarantee Your Fair Share of Stock Market Returns" (John Wiley & Sons Inc., 2007). "It is hard to imagine that even a single one of the large-cap-core equity funds has a similar record of consistency," Mr. Bogle wrote. It's equally hard to imagine an actively managed ETF doing any better, according to some advisers. "It's like putting lipstick on a pig," said Femi Shote, founder and managing director of Asset Harvest Group LLC, a McLean, Va.-based advisory firm. Mr. Femi, who uses ETFs in his practice, declined to disclose his firm's assets under management. Such resistance to actively managed ETFs, however, is only to be expected, industry experts said. Like any actively managed mutual fund, an actively managed ETF must first prove that it can add value. The success of such funds will have "a lot to do with expense ratio and whether the performance meets the expectations of advisers," said Richard Genoni, ETF product manager with Vanguard. E-mail David Hoffman at dhoffman@investmentnews.com.