The head of BGI’s iShares business discusses the company’s slumping market share numbers, ETFs still in registration, spreads and fund fees.

Lee Kranefuss, chief executive officer of BGI’s iShares business, recently took time to discuss with IndexUniverse’s Murray Coleman the future of exchange-traded funds and recent developments relating to the industry’s dominant product line.

IU:  Barclays recently renamed the Lehman-based bond indexes to the Barclays Capital moniker. Will the iShares Lehman ETFs change?

Kranefuss:  Barclays Capital completed its acquisition of Lehman Brothers’ North American Investment Banking and Capital Markets businesses. As part of the transaction, Lehman Brothers’ indices have become part of Barclays Capital. The Lehman indexes are now Barclays Capital indexes. iShares will be renaming those ETFs. It’s our practice to include the index provider in the name of the funds; we think that transparency is important for investors. People ought to know which index a fund is following.

IU: BGI’s market share as a percentage of assets under management has dropped in 2008 by more than 5% through October. At the same time, State Street Global Advisors and Vanguard have recorded more than 1% gains. What do you attribute this to?

Kranefuss: You’ve really got to look at these pieces of data over time. SSgA’s ETF assets, for instance, are concentrated in a couple of large funds that have huge swings in assets due to a large institutional base and general market sentiment.

Eight out of every $10 dollars in ETFs have flowed into iShares for several years. We built the industry, and that obviously invited competition. One wouldn’t expect that sort of concentrated asset gathering to continue. In the long run, we’re still the leading ETF provider by far in the U.S. and globally. And competition is a good thing for a new product category. ETFs are a relatively new product to a lot of people. So more assets coming into the industry is good for BGI and everyone else. It validates what we’re doing with ETFs and keeps us on our toes.

IU: BGI has 24 ETFs in registration that haven’t come out yet. Do you expect most of those to still launch?

Kranefuss:  While I’m very limited in what I can say about funds in registration, we are committed to building out the product line in the U.S. which currently has 178 ETPs. We expect that to include equities and especially fixed income, which only represents about 20% of our lineup right now. We’ve got lots of room for many new products, particularly in areas of the market that are traditionally more difficult for retail investors to access. ETFs are a huge democratizing force in the marketplace.

IU: The longer-term picture is that bid/ask spreads keep widening for ETFs. Do you see this as a systemic problem?

Kranefuss: The current widening of bid/ask spreads is reflective on the volatile markets. Typically, correlations between the spread for the ETF and the spread of the underlying securities widen by the illiquidity of the underlying markets. So dealers have to make wider spreads on the ETF. That having been said, there are times when an ETF’s spread can actually be tighter than on the underlying securities. For example, a few weeks ago the spread on the iShares iBoxx High Yield Corporate Bond Index Fund (NYSE: HGY) was 26 basis points. At the same time, the spread on the underlying basket of bonds was trading at 56 basis points. The spreads on the ETF was much tighter than if investors bought the underlying bonds as individual issues.

IU: You recently launched asset allocation funds. Who is the market for these and how will advisors use them in a portfolio?

Kranefuss: One of our key target markets is advisors. There are some segments of their business that would benefit from an ETF that offers a premixed diversified portfolio targeted to a particular date such as a child’s entering college or to a specific risk level. There are numerous other types of examples. These are another set of tools to build out a diversified portfolio. Life cycle funds are gaining increased interest in 401(k) plans and we think that the iShares asset allocation funds are an excellent option for small 401(k) plans that are often advised by financial advisors. Currently ETFs have small penetration into the 401(k) market, so we’ll see how the new funds take off.

IU: Are there any plans to lower the expense ratio on the iShares MSCI Emerging Markets Index (NYSE: EEM)?

Kranefuss:  Through time we’ve lowered expense ratios as warranted. We’re always looking for opportunities. Right now, we feel that all of our products are well-priced. You can see by how asset flows are going into funds. Emerging markets are complicated and not easy to operate a fund against in terms of benchmarking. So people have done an assessment and found that EEM is fairly priced. And EEM is a bit more institutional driven. It has been one of our fastest growing funds, even in the current environment.

IU: What do you see as the big trends for ETFs going to be in 2009?

Kranefuss: One big trend is going to be a shakeout in the industry. There are a lot of people who entered the business a year or two ago who don’t have sustainable business models. People want to invest with experienced, stable, long-term focused managers.

Another trend will continue to be the growth of ETFs. Mutual funds are losing assets. As people continue to learn the advantages of ETFs - transparency, relatively low costs, and tax-efficiency - they’re going to keep moving to ETFs. And as people face end-of-year capital gains possibilities, those advantages are going to become even more apparent.

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