ETF Update: Funds of ETFs, Active ETFs, Fundamental Indexing

Open-Ended Funds of ETFs Slow to Grab Hold

The concept of an open-ended "fund of ETFs" has yet to gain any momentum. Could it be that the right time has simply not yet arrived?

Most of these types of funds are less than two years old, and the aggregate of net assets of the group total $251.6 million, less than 1% of all fund assets, reports Richard Widows for The Street.

The most recently launched funds are Seligman Target ETF Fund 2035 [STZAX] and the Seligman Target ETF Fund 2045 [STQAX], which were released in October 2006. Year-to-date, they're both down 1.1%.

These funds are available in institutional and retirement versions, and if you buy shares of these funds, Widows wonders if the ETF exposure may justify the expenses. The exception, he says, might be investors who are making small initial investments.

Investors interested in diversification beyond what they'd get in no-load index funds might find a reason to consider funds of ETFs, as well. However, while the sales charges would likely be less than the brokerage commissions on direct ETF purchases, the expense ratios of the funds would eat into holdings over time.

For investors who are waiting for ETFs to become a standard option in 401(k) plans might find these funds useful while they wait it out.

Active ETFs and Mutual Funds Are Drawing the Battle Lines

All is not quiet on the Western front when it comes to the battle between actively managed ETFs and mutual funds.

One clear advantage active ETFs have over mutual funds is cost, report Jaclyne Badal and Leslie Scism for the Wall Street Journal. For example, the expense ratio for the PowerShares line is 0.75%, while Morningstar notes that the average mutual fund expense ratio is 1.34%.

But where mutual funds may display an advantage for the time being is familiarity. After all, name brand and performance over time has long been established within them, while many investors seem to be waiting to see if active ETFs deliver the goods before they jump in.

Active ETFs also face some real competition, as there are some low-cost and tax-efficient mutual funds with solid track records out there. They also face hurdles with the strategies for stock-picking they employ, which are largely untested.

As for taxes, perhaps they'll gain the edge. In 2007, the estimated taxes paid by taxable mutual fund investors rose 42% from 2006. Funds must distribute their capital gains, but the structure of an ETF allows it to minimize the distributions by handing over stocks to brokers and specialists so no tax bill is triggered. Mutual funds can keep tax efficiency by keeping the portfolio turnover low.

Who's the winner? Ultimately, investors are going to decide on this one. Having more choice is always good, but many might just continue playing the role of observer before they decide they'd like to step in and give these new breed of ETFs a shot.

The active ETFs currently available are:

• PowerShares Active Low Duration Fund (PLK)
• PowerShares Active Mega Cap Fund (PMA)
• PowerShares Active Alpha Q Fund (PQY)
• PowerShares Active Alpha Multi-Cap Fund (PQZ)
• WisdomTree Dreyfus Chinese Yuan Fund (CYB)
• WisdomTree Dreyfus Indian Rupee Fund (ICN)
• WisdomTree Dreyfus Brazilian Real Fund (BZF)
• WisdomTree Dreyfus Euro Fund (EU)
• Bear Stearns Current Yield (YYY)

Fundamental Indexing vs. Fundamental Indexing: Which ETFs Win?

New ETF launches are increasingly featuring underlying indexes that have been fundamentally weighted.

Two industry heavyweights in particular are big fans of the method, but they part ways on which way to do it, says Shefali Anand for the Wall Street Journal.

Jeremy Siegel, a finance professor at Wharton, and Rob Arnott, chairman of Research Affiliates, have both launched their own versions of how to do fundamental indexing better. They've created competing indexes, and ETFs have been launched to track them.

Siegel's indexes use either dividends or earnings, while Arnott's selects and weights companies based on cash flow, sales, book value and dividends.

In comparing performance, some of the funds are pretty much neck and neck and not much further apart than a percentage point or so. For example, the PowerShares FTSE RAFI US 1000 (PRF) and the WisdomTree Total Dividend Fund (DTD) are both down 5.1% year-to-date.

Some differences show up in the emerging market portfolios, though: WisdomTree Emerging Markets High-Yield Equity Fund (DEM) and the PowerShares FTSE RAFI Emerging Markets (PXH) are up 7.7% year-to-date and down 0.5% year-to-date, respectively.

Just as there's a divide over fundamental and traditional indexing, now there's intra-strategy arguing.

Why not just leave it for investors to decide? Some of them may want an ETF based on a dividend-weighted index, while others may feel that the P/E ratio is more important. There's nothing wrong with having both options available.