IndexUniverse.com assistant editor Heather Bell recently spoke with H. Bruce Bond, founder and CEO of PowerShares, about what's next for the fast-growing ETF provider.
Index Universe: What has been the key to PowerShares' success?
Bond: When we came into the market, a lot of people thought we would have trouble making it, frankly, because we were up against two of the biggest ETF providers in the world—Barclays and State Street. Even Vanguard was becoming involved in the space.
The real key to our success is the fact that we have products that are different from theirs. Although they may cover the same market segments, we seek to bring more value or more intelligent approaches to those same segments, and that's what's won over the hearts of a lot of investors.
Index Universe: Do you think that the launch of actively managed ETFs could create a new kind of competition for PowerShares?
Bond: I think it's going to be interesting. I think actively managed ETFs are a whole new marketplace that's going to open up.
We think that the active funds will ... bring active investors into the ETF marketplace. They'll appeal to investors who believe there are advantages to having a more active approach to the market, and who are thus comfortable knowing someone is evaluating each of the securities in their portfolio. We think there's going to be a lot of investors that are comfortable with that.
If you just look at the mutual fund industry, 85% of the assets are active and only 15% are passive on the retail level. We tend to think that there's going to be a lot of interest in the actively managed ETFs when, and if, they come around.
Index Universe: Is it an area that PowerShares is likely to enter?
Bond: We're keenly interested in it. PowerShares has always believed that there's an opportunity to add alpha and to bring value to investors, and we think that actively managed ETFs could achieve that. So I definitely think it's something that we are interested in.
Also, Invesco now owns PowerShares. It is one of the largest independent asset managers in the world—at about half a trillion dollars. Ninety-plus percent of their investment management is active, and we think being able to bring some of that to the table would be of value to investors in the ETF world.
[Editor's Note: PowerShares filed to launch four actively managed ETFs after this interview took place.]
Index Universe: How do you feel about how the Invesco relationship has developed?
Bond: I think it's going well. We think that we're really moving into a period where we're going to get a lot of traction out of this combined effort between PowerShares and Invesco. Within the U.S. they've been supportive from a distribution standpoint and an overall standpoint, but really one of the big advantages that they've given us is to be able to launch products across Europe ... and to look into Asia. That's something that PowerShares is looking at right now; we're in the process of expanding into those markets.
Index Universe: Where do you see the greatest opportunities on a global level with ETFs?
Bond: We think that from an absolute dollar standpoint, the largest opportunities are going to continue to be in the U.S. But the growth rate within Europe has been faster than the domestic growth rate. We believe this is going to be a global phenomenon with the ETF industry. We see tremendous growth in all of these markets. The U.S. is leading the charge, and we think that the other countries in the world will follow.
Index Universe: What's in store with your European launch? Are you going to follow the same blueprint that led to your success here?
Bond: I think we will. PowerShares' brand is really about adding value and providing investors more intelligent exposure to the markets, rather than just strictly cap-weighted beta, which we think has some flaws. Intelligent indexes, the potential for outperformance, and intelligent access are the three areas that PowerShares is focused on. I think you'll see us continue to bring products that add value over what exists in the market.
Index Universe: Are investors in Europe interested in the same types of products as investors in the U.S., or are there other areas that they're looking at?
Bond: I think it's pretty similar. You realize when you go over there that they're just as interested in commodities as we are, for instance; the same is true of currencies. I would say that they are more globally minded than we are here in the U.S. I think that we're mostly interested in domestic equities—although international investing has become much more in vogue here over the last few years. I would say that investors in Europe, as well as in Asia, are more likely to believe that there's opportunity to provide value and add alpha in a product. I think in the U.S., there are lots of individuals who feel that the market is efficient and that it's difficult to add alpha. We think that will actually be beneficial to PowerShares as we launch products in these new markets.
Index Universe: So you think that investors in Europe will be more open to the types of products PowerShares offers?
Bond: Yes, I think they're more open to it ... more accepting of it. The structured product world is very, very strong overseas, and so they're used to seeing these types of products and the type of value these products can deliver. We think our education efforts will be nothing like when PowerShares was getting started here. We had to really educate everyone on how an index can be intelligent and how value can be delivered. We think the Europeans are further along and will understand that much more quickly.
Index Universe: How important is real-time data in convincing people about the alpha-beating qualities of fundamental indexes?
Bond: We think it's important. While backtested numbers are sometimes perceived with a black mark, backtesting is a very important thing—you want to know that, at least historically, your strategy produced superior results. Otherwise, why do it? This empirical evaluation of your investment methodology is, we think, prudent.
For instance, say that you looked at the performance of the Intellidexes that are produced by the Amex. If you look at their history and then you look after the fund has started to trade, and that performance is consistent, that suggests that the backtest information was good information. This provides some insight on whether you could expect a portfolio to continue to perform as the history suggests.
Really, what the real-life data does is validate what we've seen historically. I can tell you that on the Intellidex indexes, for example, as you look back over time, we're actually slightly outperforming the historical record. So we're very comfortable with the idea that the track record there is reliable for investors.
Index Universe: What is your take on the debate about fundamental indexing?
Bond: My take is that when people call their indexes fundamentally weighted, I think unfortunately they sometimes are giving fundamental weighting a bad name.
What I mean by that is that we really see the FTSE RAFI approach as an alternative to cap weighting. PowerShares' fundamentally weighted ETFs use four different fundamentals to determine the proper sizing of a company in the economy and then weight these companies appropriately. If you look at some of our competitors' products, which might look exclusively at dividends or at earnings, that's really a stock selection process, not a weighting process.
The FTSE RAFI weights all the stocks, it just weights them based on their actual size—their financial footprint—rather than their market cap.
We think that market-cap weighting incorporates all the emotion of the market. It overprices and underprices based on market emotion. We think that creates risk for investors and is not the best way to deliver exposure. We believe a more intelligent way to deliver exposure is by asking, "How big are these companies based on their true size and their true financials?" I think that what empirical evidence shows is that fundamental weighting provides, in a sense, more intelligent beta. It doesn't incorporate the emotion of the market, and so sometimes it gets painted as more of a value strategy because it's not overpricing the market. I think a cap-weighted structure inherently, without question, overweights overvalued stocks and underweights undervalued stocks. Therefore, you don't get as pure exposure to the market as you could.
Index Universe: A while ago, PowerShares filed with the SEC for a closed-end fund that would convert to an ETF if the discount grew too large. Where is that in the development process?
Bond: We're still evaluating some things and fine-tuning the structure. We continue to believe that this is a tremendous product.
It's important to understand that it's not an ETF; it's a closed-end fund. The goal is not to get assets in the ETFs but to repair or fix the Achilles' heel of the closed-end fund industry, which is that the funds often trade at a discount to net asset value. What our structure does is provide reliable discount protection. We think it is a very innovative and novel approach.
Index Universe: What does a closed-end fund offer that ETFs do not provide?
Bond: I think what closed-end funds offer is much more flexibility for the manager. You can use leverage, you can use options and you can have a more subjective approach to investing.
You also have an environment with closed-end funds where you're not taking cash in and cash out: You're just investing the money that's within the portfolio, which allows the manager to do a much better job than if he/she has to deal with redemptions. I think the important thing to know is that the closed-end fund industry is a multibillion-dollar industry. If we have the opportunity to provide a better product within that industry that protects investors, we think that only improves the industry overall.
Index Universe: How does the partnership with Deutsche Bank on the commodity ETFs work? Are there going to be more products along those lines?
Bond: We have a great relationship with Deutsche Bank, and we think very highly of the individuals there. I think that we're always evaluating whether or not more products make sense.
The funds are based on Deutsche Bank indexes and Deutsche Bank actually manages the money within the funds. PowerShares provides the marketing, sales and all of those things to Deutsche Bank so that the products can get the visibility that they need in order to garner assets.
Index Universe: The QQQQ is your biggest product. Do you see that having a lot of further asset growth?
Bond: We do see opportunities for it, and we continue to talk about it when we're in offices with investors and advisors. It is the most traded security in the world, and it provides a tremendous amount of liquidity; there are a lot of institutional investors (as well as individual traders) that use the QQQQ to trade. We think it's providing a very important tool to them.
Some of the things that we're planning to do are to launch products around the QQQQ that could potentially bring value to these traders, giving them things to trade with or against.
I can't really say more about those yet, but I think these things will be of interest for traders and will potentially create more trading in the QQQQ as well.
Index Universe: How do you invest your personal money and do you own any PowerShares?
Bond: Oh yes, definitely. I would say that a bulk of the invested assets I have are in PowerShares—and more all the time. I definitely have a substantial amount of capital in PowerShares.
