Where ETFs and Indexing Are Getting It Right

What are the biggest things going on right now in the index and ETF industry?

I think the key thing is highlighted by Matt Hougan saying 5 people came up to him to ask what he thought of fundamental indexation. The stakes around this are huge, and it's why the industry has responded so forcefully to Rob Arnott (and Jeremy Siegel among others). These ideas take aim at the very heart of indexing, as I've mentioned in this blog previously.

But something that I think may be getting lost on some folks is that right now this is a very intellectual debate, and at least in the retail arena, it's happening on the very outer reaches in the realm of index intelligentsia, like a fringe liberal think tank in the political realm. The institutional arena is where the real fight is playing out, with some substance (and dollars) attached to it. And at least on the index provider side, that's where everyone's aiming. That, my friends, for all the talk of ETFs driving the BGI train, etc., etc., is the franchise for index providers.

Still, the ETF guys have all the fun. With all the wacky new products that are being launched, thanks ETF product issuers for putting the "ing" in indexing in about 500 different ways.

I know we've listed the big recent developments, but here is what some of the other main ones are to me. Most important is the opening up of a ton of interesting new investment areas, some of them actually quite valid and interesting even to fuddy duddy index types like me. Particularly in the international and commodities areas, there is a lot I'm excited about. From a product structure standpoint, some of the bond products are also very cool. As I debated at dinner last night, I'm not convinced that from an investor standpoint they're getting us much, but they're very interesting to the ETF geek part of me.

Here's my theory. For ETFs, on the equity side, the pure ETF structure has a clear advantage on tax efficiency because it's able to keep the cost basis high. I know Gus Sauter debates even that and says that the share class structure handles the issue. But this is an advantage for the "pure ETF" I'd say, all other things being equal (which, granted, often they are not). For bonds, however, and arguably some other illiquid asset classes, the hybrid structure or even pure fund structure can be better from both (ironically) a diversification AND leanness-of-creation-unit standpoint. And then these ETNs, well, they just potentially could change the whole landscape in terms of the tax issues for their asset classes.

Sorry, that was a bit of a digression. My other big issues would be the ETNs, and next, the move toward more and more active-like funds that are really going to need to be sold. The days of launching into pent-up demand are coming to an end I'd say. I think ProShares has got a piece of that w/ the international leverage they'll have coming out. Maybe some of these synthetic institutional strategies could get a foothold. And also, I think the target-date funds are potentially exciting. But honestly, that's most of what I see on easy big bang. Because all the sudden, everyone is everywhere and the competition is already fearsome—and it will only increase.

So just as the dynamic in the ETF industry has shifted from trading-based (heck, the first ETF was launched by an EXCHANGE) to asset-based (with VC firms in an odd way sort of replacing the role that specialists used to play to some degree), products are increasingly being SOLD and not BOUGHT. This is not an encouraging trend on the surface, but there's no arguing that all of that competition is resulting in more and better products. So if you know what you're doing, the shifting dynamic is still getting us where we want to be. And if you don't know what you're doing, you're completely confused if you're trying to understand the exchange-traded product market.

Just keep reading Hougan. He'll straighten it out for you...

Written by Jim Wiandt

Comments

[Wise Owl]

ETF's are being sold rather than purchased by informed investors and I agree with that assessment.

It has become more and more important to provide exposure th foreign markets like BRIC regions and they will be the low cost producers for most of the goods and services for some time to come.

INP, a ETN for India is difficult to figure out with an overall expenses ratio of 1.0 percent. It seems that the sponsor has done this exposure to 58 or 68 stock basket...

I like the ETN, but donot know, if it safe to trade...

I think the money in Mutual Funds will be less and less, due to subpar performance as well as higher expenses...

Thanks...and welcome o the world of ETF's and ETN's..

2007 Sep 22 05:52 PM