Can New ELEMENTS Platform Wide Moat ETN Challenge iPath's Dominance?

Deutsche Bank ushered a new exchange-traded note [ETN] to market last Thursday. The ELEMENTS Wide Moat Focus ETN (WMW) tracks the Morningstar Wide Moat Focus Total Return Index and trades on the NYSE Arca.

The index was launched in April and was inspired by a phrase used by Warren Buffett, who used the term "wide moat" to describe companies with sustainable competitive advantages. The index includes companies that fit the "wide moat" description according to Morningstar, which evaluates a company's "moat" based on criteria such as patents, copyrights, cost advantages versus competitors, customer-switching costs, government protections and economies of scale. It identifies approximately 10% of the members of its broad U.S. market index as having a wide moat; the components of the Morningstar Wide Moat Index represent about 1% of the total companies in the broad index.

That broad list is narrowed down into the Morningstar Wide Moat Focus Total Return Index, which includes the 20 "wide moat companies" with the best Morningstar price/fair value ratios. The Morningstar price/fair value ratio represents the differential between a company's trading price and what Morningstar has estimated to be its fair value based on its discounted cash flow model. WMW has an annual expense ratio of 0.75%, as do the rest of the ETNs in the ELEMENTS family.

In all, there are five ELEMENTS ETNs in addition to WMW. Four track the Rogers International Commodity Index and its Metals, Agriculture and Energy subindexes, while the fifth is linked to BNP Paribas's SPECTRUM Large Cap U.S. Sector Momentum Index. The six funds have total assets of roughly $32 million.

The ELEMENTS family of ETNs is an open architecture platform used by partnerships among industry participants to bring new ETNs to market. Currently, it has two investment-grade issuers, Deutsche Bank and Swedish Export Credit Corp. [SEK]. Merrill Lynch subsidiary Merrill Lynch, Pierce, Fenner & Smith Inc. and Nuveen Investments are on board as distributors, while the index providers include Beeland Interests, BNP Paribas and Morningstar. The platform has individual products listed on three exchanges: NYSE, NYSE Arca, and the American Stock Exchange.

The ELEMENTS platform may represent the strongest potential competitor to Barclays Global Investors' iPath ETN family and the best chance for newcomer firms to get a foothold in the space. For one thing, multiple investment-grade issuers mean the risk will be spread out across more than one firm. Investors might hesitate to construct portfolio strategies with multiple iPath ETNs because with Barclays as the sole issuer, the credit risk is far more concentrated. Should the number of issuers and products on the ELEMENTS platform expand significantly, investors could put their money into a variety of ELEMENTS ETNs knowing their credit risk was spread across multiple issuers.

For those involved in the creation and marketing of the ELEMENTS ETNs, the platform could provide a way for an alliance of firms to give BGI some real competition. BGI is a behemoth in the exchange-traded products arena. With more than 140 ETFs trading in the U.S. and billions of dollars in assets, it dominates the ETF market and was also the first mover in the ETN field, where its iPath family of ETNs now has $3.6 billion in assets. The ELEMENTS platform could potentially give other firms a chance to carve out a space and head BGI off before it establishes a dominant presence in ETNs similar to its role in the world of ETFs. However, any firms looking to go head-to-head with the iPaths better hurry, as BGI just doubled its number of offerings with the launch of eight new ETNs tracking subindexes of the Dow Jones-AIG Commodity Index. (You can read the article here.)

Written by Heather Bell

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