Handicapping the ETF Issuers: A Rebuttal

Jim Wiandt handicaps the ETF industry like it's Lake Wobegon: All the men are strong, all the women are good-looking and all the ETF providers are headed for glory.

(Jim's blog handicapping the issuers is available here.)

To recap ... you love Van Eck; love State Street; think Vanguard is going to take over the world; see good things for Rydex, Claymore and WisdomTree (WSDT.PK); and are bullish on SPA, Focus Shares and the rest of the lot. Even MacroShares, which Greg Newton says should be summarily shut down, gets a homily to their think-tank-style hopes and dreams.

Let's get real.

I'm as bullish as anyone on the future of the ETF industry. I think ETFs are a better mousetrap and will come to dominate the mutual fund space over the next 10-20 years. But I also think there will be a shakeout, and that the ETF industry of tomorrow will not necessarily reflect the ETF industry of today. Some of the current providers will shut down or be swallowed, and some companies that aren't even on the scene today will make a huge leap into the space.

Right now, you can draw a line in my ETF league table somewhere around Claymore and say for sure that all the companies below that are losing money on their ETF operations (some of the companies above the Hougan Line are losing money too). The asset management business is a fantastic business, but 50 basis points of $1 billion is only $5 million a year, and it costs real money to run these things.

Will these providers boost their assets quickly enough to stay in the game? Long term, I bet there is room enough for everyone. We may even still be early enough for all of these providers to make it. But it's going to require execution ... and it's going to have to happen soon.

As you and I know, this can become a self-fulfilling prophecy. If rumors start swirling that an ETF provider may shut down, investors will stay away from the funds; no one wants to get caught holding a fund during liquidation. Already, some firms don't let their brokers trade ETFs that fall shy of a certain asset count - be it $10 million, $100 million or more.

The ETF providers know this. It's the reason WisdomTree was so eager to build its cash reserves that it priced a secondary offering at a 60%+ discount to its stock price in December 2006; it's the reason XShares is so aggressive about projecting confidence about the company's future; it's the reason ETF providers spend money building sophisticated Web sites that create a strong public face. You have to give off the aura of confidence.

The key for all these firms is to develop products that break new ground and make sense for investors and/or traders. Me-too products won't work.

I will say this, too: The trader market should not be overlooked. Almost all of these providers are focused on serving the advisor market, probably because advisor assets are sticky. But today, a huge chunk of total ETF assets are in the hands of traders - just ask ProShares, which has gathered $9 billion in assets with an average holding period of two weeks. Servicing this market - designing products that work for traders - is an overlooked corner of the ETF space.

Written by Matthew Hougan

Comments

[flstearns]

You do some waffling as well, when you don't suggest a figure below which an ETF family is risking failure.