ETF industry chugs along with new products

PHILADELPHIA — The exchange traded fund industry is tripping over itself to come out with new buzz-worthy products. “Money is pouring [into ETFs], and people are trying to capitalize on it,” said Richard Romey, president of ETF Portfolio Solutions Inc., an Overland Park, Kan.-based adviser that specializes in the investments. Overall, ETF assets rose to $433.4 billion in February, up $2.32 billion, or 0.5%, from the level in January, according to the most recent data from the Investment Company Institute in Washington. During the 12 months ended Feb. 28, assets jumped $110.99 billion, a 34.4% increase. March madness The result has been a boom in the number of ETFs. Last month alone saw the debut of 45 ETFs, bringing the total to 432 managed by 15 asset managers, according to the most recent data from State Street Global Advisors of Boston. Bear Stearns Cos. Inc. of New York made the biggest wave last month when it filed to offer the first actively managed ETF, called the Bear Stearns Current Yield Fund. The Bear Stearns ETF, however, is a money-market-like fund, noted Sonya Morris, editor of Morningstar ETFInvestor, a newsletter published by Morningstar Inc. of Chicago. Portfolio transparency — which the Securities and Exchange Commission has identified as crucial to an ETF’s ability to trade — just isn’t as important to such a fund as it would be to an actively managed ETF that invests in equities, she said. Although arbitrageurs could make a killing gaming the trades of an actively managed ETF that invests in stocks — thus hurting its performance — it would be much harder for them to make money gaming trades made in a short-term bond ETF, Ms. Morris said. “I think it really doesn’t give us insight on how to get around [transparency] on the equity side,” she said. Not that the industry isn’t trying to come up with a solution. The American Stock Exchange LLC in New York has developed a system it has been shopping to various asset managers that involves the creation of a proxy portfolio. The proxy portfolio would allow for intraday pricing without investors actually knowing the exact trades being made by the fund. “We’re having a lot of conversations with major [investment] houses,” Charles A. “Tony” Baker, managing director of the exchange traded marketplace at the Amex, said at last month’s ETF Evolutions conference in New York, concerning the exchange’s efforts to make actively managed ETFs a reality. Few industry watchers are convinced, however, that investors will see actively managed ETFs — at least those that invest in equities — anytime soon. “Is it going to happen in 2008? No,” Herb Blank, founder and president of QED International Associates Inc., an industry consulting firm in New York, said at the ETF conference. It is much more likely the industry will continue to see ETFs based on indexes that blur the boundaries between active and passive management, industry experts said. They point to the development of such “intelligent” indexes as those that underlie ETFs offered by PowerShares Capital Management LLC of Wheaton, Ill. PowerShares executives, however, don’t think that the indexes — which were developed by the Amex — underlying its ETFs chase returns or cross the line into active management. Although the indexes the company’s ETFs follow aim to add value, they still are rules based and won’t deviate from those rules, PowerShares president Bruce Bond has said. Other companies are following in PowerShares’ footsteps. For example, First Trust Advisors LP in Lisle, Ill., has plans to roll out a suite of ETFs pegged to AlphaDex indexes, described in registration statements as “custom enhanced.” Not all financial advisers are happy about that. The ETF industry is beginning to stray from its “roots” of providing low-cost, transparent products, Mr. Romey said. Instead of running from that legacy, the industry should embrace it, he said. It is a mistake, however, to think that just because the industry is developing products designed to outperform a benchmark means that it has turned its back on its past, said Richard C. Kang, an industry consultant in Toronto. There is a place for new “alpha” generating ETFs, just as there is a place for the more traditional ETFs, he said. “It’s a win-win situation,” Mr. Kang said.