Herb Morgan (Efficient Market Advisors, LLC) submits: I finally had time to review the Proxy related, among other things, to the proposed acquisition of PowerShares Capital Management LLC by AMVESCAP PLC and AIM Management Group. I have noticed some interesting tidbits worth pointing out. Readers should review the proxy carefully and make their own conclusions before casting a vote.
First, it is no secret PowerShares are priced more expensively than the other ETF fund families. I was particularly amused by the following statement contained in the proxy:
The Trustees noted that the advisory fees were at the higher end of the ETF universe.
What the proxy does not detail is what if any serious shopping the trustees did of the management contract before blessing this deal. AMVESCAP & AIM can’t buy the management contracts of the fund; the law simply does not allow that to happen. In order for the Buyers to take over management of the fund they must obtain a new management contract with that fund, or in this case, all of the PowerShares funds. I would think that trustees in this instance would take the opportunity to seriously review their contracts with PowerShares and perhaps put them out for bid with other players in the ETF management business such as Barclays, Vanguard, or StateStreet. The valuation (price) received by the sellers is primarily determined by the revenue generated from the contracts, so any fund management fee reduction achieved by the trustees would have significantly negatively impacted the sales price of PowerShares Capital.
One other item worth looking at is the statement:
The Trustees noted that the Adviser had not identified any further benefits that it derived from its relationship with the Funds, and had noted that it does not have any soft-dollar arrangements.
There is no statement regarding AMVESCAP & AIM’s soft dollar arrangement with broker dealers. ETF’s by their nature generate little in the way of trading commissions, however an astute reader would note that AIM is a major broker dealer distributed fund family and could, if it was so inclined, benefit in the future from soft dollar arrangements generated by the PowerShares funds and others it manages.
The second proposal asks shareholder to approve a change in the classifications of each PowerShares fund’s investment objective from a fundamental to a non-fundamental investment policy. This would allow the investment manager to change the funds investment objective in the future without shareholder approval. I am wondering if the astute buyers at AMVESCAP have uncovered some flaws or areas of concern relating to the indexing methodology employed by PowerShares. I have written critically in the past about the PowerShares Value Line Timeliness Select Fund (PIV) as an example. I wonder if the request outlined in the proxy is in any way related to particular problems associated with any funds. We will know more after the proposal passes, as it surely will.
Proposal Three asks shareholders to approve a change in the status of the PowerShares Golden Dragon Halter USC China Portfolio (PGJ) from a diversified fund to a non-diversified fund. This I would assume comes as a result of the fund underperforming its USX China Index by 112 basis points over the twelve month period ended 3/31/2006 as reported on the PowerShares website. Being a diversified fund has some benefits to shareholders most particularly, risk reduction associated with the rule that limits a fund from investing more than 5% of it total assets in any one security. Further, a fund is prohibited from owning more than 10% of the voting securities of any one issuer.
The fund is having trouble tracking the index because its top three companies each contribute more than five percent to the index. Equal weighting the index is out of the question due to liquidity concerns. The index itself only requires $50 million market cap for eligibility of an issuer. The real problem not being addressed here as well as in other ETFs which invest in smaller capitalization areas is there just isn’t enough liquidity to justify the product in the first place. It is precisely the reason why MicroCap ETFs have such a large percentage of their assets squirreled into Russell 2000 companies. The lack of liquidity in the underlying index components of ETFs is at least partly responsible for the run up in several areas where flows of capital to ETFs have been driving up prices..
Most investors could learn a great deal from proxy statements, annual reports, and SAI documents. Sadly, most of these documents go unread by lay people and professionals alike.