ETF Update: Actively Managed ETFs, Usage Data, New Lehman ETNs, Short ETFs

No Overnight Success For Active ETFs

Actively managed ETFs have been the talk of the town, however, assets will take time to gather and success will not happen overnight.

The SEC is closer than ever to approving the launch of active ETFs which would not track a set index. The funds, which have been in the approval process for years, have finally cleared some hurdles and are waiting to be cleared for liftoff, reports John Spence for MarketWatch.

At first launch, active ETFs will be running without a track record, without active managers who are known quantities with advisors and investors.

Active ETFs are a different breed, and they will not track a set index, so investors will be left to put their faith in the managers' stock-picking skills. These new funds will be starting from scratch, and they will have to work to build trust and garner assets.

PowerShares President Bruce Bonds believes that once investors sit down and compare active ETFs with mutual funds, investors will be won over by their transparency (holdings will be disclosed once a day), low cost, tax efficiency and liquidity.

ETF Usage Data

ETF usage was recently explored by the Advisor Perspectives Universe.

The data, gathered on Feb. 28, was interesting:

• ETFs now hold twice the assets of index funds (70.3% vs. 29.7%). ETF assets increased from 65.0% to 70.3% over the prior five months.

• ETFs and Index Funds now represent 32.9% of total mutual fund assets, up from 29% on Sept. 30, 2007 and 27% on June 30, 2007.

• ETFs and Index Funds now represent 6.4% of total marketable securities in the AP Universe, up from 4.6% on Sept. 30, 2007 and 3.9% on June 30, 2007.

• Holdings tied to broad-based indexes increased, but still represent a relatively small portion of overall assets in the AP Universe. Holdings tied to the S&P 500 increased from 17.3% to 24.5% of total mutual fund assets from Sept. 30, 2007 to Feb. 28. Holdings tied to the EFA increased from 17.5% to 20.4% over the same time period. Holdings tied to the total market decreased slightly, from 4.5% to 4.3%.

• Holdings in sector-based ETFs decreased consistently from Sept. 30, 2007 to Feb. 28 (as a percentage of mutual fund assets) and continue to remain a small percentage of ETF holdings.

For more interesting numbers and insight, check out the tables on the site.

New Lehman ETNs

Lehman Brothers Holdings (LEH) has jumped onto the ETN bandwagon, just as the tug-of-war between ETFs and the notes heats up.

John Spence for The Wall Street Journal reports that last month the company listed a trio of ETNs, and plans to launch more because some ETNs cover a more illiquid market better than ETFs. The funds are welcome additions, as two of them track the red-hot commodities market and a third follows a private commodity index.

Although ETNs and ETFs are often mistaken as alike, the approach is very different. An ETN is a long-term debt security issued by the investment manager. They promise to pay back the return of a certain index, minus the fees.

ETN investors take on the credit risk that the issuer will be solvent when they want to sell shares or when they reach maturity. Index tracking error gets shifted to the issuer, not the investor.

ETNs took a hit last year when the IRS took away the tax advantages of notes that provide exposure to foreign currencies. A decision on the taxes for commodity and stock ETNs is in a public comment period, but if the IRS makes a ruling against them, it could be a sharp blow to the business.

Lehman is undeterred, though, saying that they believe ETNs have a place in investor portfolios regardless of their tax treatment.

Barclays (BCS), Goldman Sachs (GS), Bear Stearns (BSC) and Deutsche Bank (DB) are other ETN providers.

Short ETFs: Proceed With Caution

In a down market, short ETFs gain popularity, but they need to be used with caution and education.

ProShares UltraShort QQQ (QID) is one of the more popular ETFs of this kind and it tracks the Nasdaq 100, while returning twice its inverse performance. The ETF has $1 billion in assets, and returned 38.8% year-to-date, but it is against a -5.1% return over the past year, says Jesse Emspak for Investor's Business Daily. It's benefited from the decline of the Nasdaq, which is 2.3% below its Jan. 22 low.

Among the strongest of performers is the ProShares UltraShort Semiconductor (SSG) which has given investors 39.5% year-to-date, with a one-year return of 10.4%. The semiconductor industry has been ailing so far this year.

Investors should consider two things when considering short ETFs:

1) Markets tend to go up over the long run, so shorting ETFs are not a long-term investment.

2) There is a strict limit on the gain any short can make. The value of the index should not go below zero.

UltraShorts can make a bad day in a particular sector - this morning's financials, for example - a good one for investors who hold short funds, says Will Swarts for Smart Money. ProShares says their Ultra funds family isn't targeted to the "mom and pop investors."

But for sophisticated investors, ProShares Chief Executive Michael Sapir says they can be a great way to capitalize.

Making sector calls can work, but just be sure you have your exit strategy in place before you get involved. We watch the 200-day moving average and put an 8% stop-loss on each ETF.