ETFs As a Price Discovery Tool

| About: PowerShares Buyback (PKW)

Matt Hougan's illustration of the Powershares Buyback Achievers Fund's (NASDAQ:PKW) underperformance is really interesting, and shows how ETFs can act as a window on markets.

Obviously any evidence of the first blush of performance of the buyback fund needs to be taken as anecdotal. The first lesson in Economics 101 (heck, in Science 101) is that just because factors correlate over some time period does not mean they're connected. Still, conventional wisdom absolutely is that buybacks increase stock performance, though reflecting on this, it wouldn't necessarily be the case, for all the reasons Matt illustrates.

I just wrote a whole paper in this (anecdotal) line — coming out in the November Journal of Indexes and Institutional Investor ETF Guide — on fundamental indexing and how it has performed out of the gate (not so well). So anecdotal yes; worth looking at in the context of a very rosy picture that has been painted, absolutely.

Still, presumably the guys who build the index underlying that PowerShares fund must have some good backtested data on buyback performance. In any case, it does strike me as a nifty little idea and not just Bond throwing another one up on the wall, as his detractors would say. Bear in mind (and this came up on the Financial Advisor Symposium panel I just did) that "throwing it up on the wall" has gotten PowerShares, I think they said, $33 billion in assets (if you include the $20 billion in QQQQ — and still a ton of money if you do not) in the last three years. So I think Bruce Bond can probably put up ok with being made fun of.

But I digress. What makes this fund and Hougan's column interesting to me far beyond whether or not the buyback fund has any investment merit is what it does. Effectively, it acts as a window into a corner of the stock market that might not otherwise be visible.

So now we can see (and in real time) how companies that do big-time buybacks actually perform. That's nifty. Even niftier are ETFs that effectively do the same things in illiquid or less-transparent asset classes. I think it's cool to no end (and I know that brands me as a huge geek) that fixed income ETFs effectively show you what bond price movement means in real time in real dollars and cents, even when the bonds are not actually trading. I just think that is handy — and as a bit of a fixed income novice, looking at price movement and dividend payout daily helps me understand bond markets a little better.

Same deal times ten for, say, the Malaysia iShares ETF (NYSEARCA:EWM) (then technically a Web) when the Malaysian government froze currency and equity market trading. That ETF was effectively the price discovery mechanism of where the Malaysian currency/market stood. Nifty. And the article I wrote for ETFR on how the WSJ guys got the tracking "problems" of the iShare FTSE Xinhua ETF (NYSEARCA:FXI) wildly wrong - same deal. The ETF was on the project.

So that's just another interesting positive for ETFs, which generally reflect the market, but in odd circumstances can lead it as a price discovery mechanism, and in many other instances can illuminate parts of the market we would not otherwise be able to see priced in so clearly or in real time.

Written by Jim Wiandt