• Pfizer (NYSE:PFE) bettered earnings and revenue expectations with third quarter adjusted results of 51 cents a share, 3 cent higher than Zacks estimates, on revenues of $11.6 billion, which beat Zacks estimates of $11.47 billion. Full-year guidance was also raised to $2.00-$2.05 from $1.90-$2.00 prior

• United Technologies (NYSE:UTX) third quarter numbers beat consensus estimates with earnings of $1.14 versus Zacks estimates of $1.12 on revenues of $13.38 billion up from estimates of $13.40 billion. The firm expects full year earnings in the mid-point of its earlier guidance of $4.00-$4.20

• State Street (NYSE:STT) reported third quarter operating earnings of $1.05 a share, beating Zacks estimates of $1.00 a share, as revenues of $2.77 billion were above estimates of $2.22 billion. However, the company lowered full-year operating results from $4.25-$4.50 to $4.13-$4.17

• Comerica (NYSE:CMA) reported third quarter earnings of 10 cents, versus Zacks estimates of a 54 cent loss, with $311 million provided for loan losses

• Bank of NY Mellon (NYSE:BK) reported third quarter earnings of 54 cents a share, beating Zacks estimates by 7 cents, on revenues of $3.33 billion versus $3.20 billion

• DuPont (NYSE:DD) reported third quarter earnings of 45 cents, 12 cents better than expected, on revenues of $5.96 billion versus $6.14 billion. The firm sees full-year results of $1.95-$2.05 versus $1.83. According to the firm, "We see overall sequential improvement in our industrial businesses as market conditions begin to firm"

• Caterpillar (NYSE:CAT) reported better-than-expected earnings and revenues with earnings of 64 cents 57 cents above Zacks projections as revenues reach $7.29 billion versus $7.53 billion. "We believe the third quarter marked the low point for Caterpillar sales and revenues in what has been the toughest recession since the 1930s. We are seeing encouraging signs that indicate a recovery may be underway"

• Coca-Cola (NYSE:KO) reported quarterly results of 82 cents versus Zacks estimates of 81 cents on revenues of $8.04 billion versus $8.03 billion.  According to the company, "We expect the consumer to continue facing economic uncertainties into 2010 and for consumer sentiment to recover slowly"

• Qatar announced plans to sell its $2.1 billion Barclays (NYSE:BCS) stake, locking in a $1.2 billion gain in the shares

The Dollar

First, let's take a look at what a survey of approximately 50 banks and financial firms indicates, for the value of the dollar (Fed broad index) and the euro/dollar exchange rate.

The data are from FX4casts, which is the successor to Currency Forecasters Digest; Jeff Frankel and I used these survey data in our studies of expectations in foreign exchange markets [1] [2] [3]. Some additional results are reported in [4] and [5].

Both series are plotted in logs, and exchange rates defined such that up implies a stronger dollar. In both cases the 95 percent interval is shown. What is clear is the (geometric) mean forecast for the dollar implies relative stability. It's true that the lower bound implies some depreciation over the next year -- but no more than 5.6 percent decline (in log terms). That's hardly calamitous. But it would be helpful in terms of facilitating rebalancing (as I pointed out a few weeks ago [6] [7], dollar decline makes a lot of sense, perhaps even more than the 5.6 percent implied by the lower bound).

If one is more concerned about the dollar's value against major currencies (perhaps because of an interest in cross-border valuation effects on financial assets), one would want to see how the dollar evolves against the euro. Here, it appears the mean forecst implies strength over the medium term. Even the scenario for the weakest dollar implies no more than a 7.5 percent decline, at the 3 month horizon.

More from US Treasury's semi annual report and from Fred Bergsten in Foreign Affairs. Appendix I to the Treasury report discusses the dollar's reserve currency status, a topic discussed in a historical perspective by myself and Jeff Frankel here and here.

Double-dip Recession?

Anxiety remains (rightly so) that the economy will suffer a relapse, with the date perhaps in 2010 or 2011. The latest WSJ survey indicates little evidence of such fears.

The mean forecast suggests a story largely consistent with last month's forecasts. The biggest revisions (upward) came between the August and September surveys. Even then, it won't be until close to end-2010 that GDP reattains its previous peak. Forecast dispersion remains large, though, and the trimmed high (Dean Maki, Barclays) indicates reattainment around mid-2010.

The trimmed low (David Malpass) is, interestingly, kind of a "W", although not the typical discussed one; Malpass forecasts 0% SAAR growth in 2009Q4. Bart van Ark (Conference Board) has a drop in growth to 0.5% SAAR in 2010Q1.

Of course, these are conditional forecasts -- that is they incorporate assumptions regarding a certain combination of fiscal and monetary policies. I would guess most of them are assuming "reasonable" policy mixes. But some of the recent discussions of "W" relate to mistakes in policy making, such as a too-early monetary tightening (Roubini, Krugman) or inadequate stimulus (Krugman) or the time profile of the stimulus (Feldstein).

• Barclays (NYSE:BCS) reported plans to spin off a $6.35 billion portfolio of complex credit assets as it seeks to clean up its balance sheet

• Phillips Electronics (NYSE:PHG) reported better-than-expected third quarter earnings, helped by cost-cutting measures, although the company said most markets are yet to see recovery

• Deutsche Bank (NYSE:DB) lifted Johnson & Johnson's (NYSE:JNJ) price target to $67 from $63 and maintained its "buy" rating on the stock, as the analyst noted "Ahead of Tuesdays earnings call we are raising our price target to $67 (prior $63) based on improving comparable multiples, new product approvals, stabilization in the global economy, and FX tailwinds all [of] which should add to earnings in 4Q and next year. We expect management will focus on continued healthy trends in its Medical Device & Diagnostic division, which will be the highlight of Tuesday's earnings meeting"

• Goldman Sachs' (NYSE:GS) removed Johnson Controls (NYSE:JCI) from its Conviction Sell list in anticipation of optimism after its October 13 analyst day.  Goldman raised its price target on the firm to $20 from $18

The chart below shows the Counterparty Risk Index (CRI) history since the beginning of 2008. The index is an unweighted average of the credit default swap spreads of 14 major financial institutions. The left-hand scale gives the cost (in basis points) of insuring against default for a five-year term.

The three big spikes on the chart mark the near-failure of Bear Stearns (in March 2008), the Lehman default (September 2008) and renewed concerns over bank safety at the market’s nadir in March 2009.

If crises appeared at six-monthly intervals since last spring, this time we appear to have broken out of the cycle.

What about the individual banks that make up the index? Here is a chart, courtesy of CMA Datavision, of the CDS spreads of the U.S. bank members of the index, plus Barclays and Deutsche Bank, the leading players in the U.S. exchange-traded note market.

Citigroup now ranks as the riskiest U.S. bank, and JP Morgan as the least risky, though it’s fair to say that the CDS spreads have converged significantly and there is far less difference between individual names than there was a year ago.

For the record, here are the levels from earlier today, ranked from least to most expensive to insure against default: JP Morgan (72bp), Barclays (76bp), Deutsche Bank (82bp), Goldman Sachs (107bp), Bank of America (120bp), Merrill Lynch (137bp), Morgan Stanley (140bp) and Citigroup (200bp).

(The fact that the Merrill Lynch CDS trades at a slight premium to that of Bank of America, its owner, is interesting.  This reflects speculation that the broker may yet be spun off from the parent bank, in which case the CDS would follow the reference entity, Dave Klein of Credit Derivatives Research told me.)

The levels should matter to exchange-traded product investors: All of these banks except Citigroup underwrite exchange-traded notes.

Is the worst now over? As Gillian Tett noted in a column in last week’s Financial Times, the concentration of overall (gross) risk in the credit derivatives market amongst the leading banks has actually risen since the AIG bailout of last September, and regulators are still finding it difficult to assess whether banks are handling their net risk exposures sensibly.

And, in what sounds like the ultimate reinsurance spiral, banks have become net sellers of protection on sovereign debt; hardly reassuring if one remembers that the banks are themselves propped up by the governments concerned. Lloyd’s, anyone?

So, while the reduction in overall default risk so far this year will come as a reassurance to investors, these are charts that are worth keeping an eye on.

The Dow Jones industrial average jumped 124 points, or 1.3% and the broader S&P 500 index rallied 19 points, or 1.8% and the Nasdaq composite index advanced 40 points, or 1.9%.  The share gains were broad based with 28 of the 30 Dow components advancing.  On the New York Stock Exchange, four stocks rose for each one that declined in price.  Only 978 million shares exchanged hands on the NYSE.  Trading was light due to the Jewish holiday of Yom Kippur.     

In a spate of big corporate merger announcements, Abbott Labs (NYSE:ABT) said it will pay $6.5 billion for Solvay's pharmaceutical business, and Xerox (NYSE:XRX) offered to pay $6.4 billion in cash and stock for Affiliated Computer Services (NYSE:ACS).  Johnson & Johnson (NYSE:JNJ) said it will pay $444 million for an 18% stake in Crucell (NASDAQ:CRXL).  The announcements signaled corporations’ belief that equity markets still offer values, while economic conditions support a growth environment for purchases made.

The financial, basic materials, and oil & gas sectors were among the leading gainers yesterday.  Even as stock prices rose, Treasuries advanced and the corresponding yields fell, with the yield on the 10-year notes declining to 3.28% from 3.32%.

Yesterday's strength was broad-based with 28 of the DJIA's 30 components moving higher, and all ten S&P 500 industry sectors marking gains.  Financials (+3.4%) were the leading gainers, with American Express (NYSE:AXP) up 4.1% and Bank of America (NYSE:BAC) rising 3.7%.  Morgan Stanley (NYSE:MS) said it expects banks' credit losses to decline over the next 12-18 months, and noted large-cap banks are "largely done with capital repair."

Analyst upgrades also helped much of the rally yesterday, with Citigroup (NYSE:C) shares jumping 4.3% on an analyst upgrade. Cisco (NASDAQ:CSCO) rallied 4.4% after Barclays' (NYSE:BCS) upgraded the stock to "overweight" from "equal weight," citing prospects in Europe and momentum in the US. Applied Materials (NASDAQ:AMAT) jumped 3% on a Citigroup (NYSE:C) upgrade to "buy" on opportunities in its solar-power operations.  However, MEMC Electronic Materials (NYSE:WFR) shed 3.1% after Citigroup (NYSE:C) cut its rating to "hold" from "buy", noting recent poly production problems remain unresolved.

The notes offered by this prospectus supplement will not be listed on any securities exchange. Currently, there is no public market for the notes. Barclays, Goldman Sachs (GS) and Wells Fargo (WFC) were the joint book running managers for the sale.

Interest will be payable on the notes on April 1 and Oct. 1 every year at a 4.70% coupon rate. The first interest payment will be made on April 1, 2010. The notes due on Oct. 1, 2019, will be denominated as senior unsecured debt obligations of Burlington.

The company plans to use the net proceeds for general corporate purposes, including potential buyback of common stock, capital expenditures and the repayment of debt. Such debt may include its 7.125% notes, which will mature on Dec. 15, 2010. The notes will not be entitled to the benefit of a sinking fund.

It is to be noted that the Burlington has been able to maintain its ability to pay fixed charges, witnessed by an uptick in the ratio of earnings to fixed charges that stood at 5.04X in 2008, compared to 4.62X in 2007.

Rating agencies Moody’s and S&P have rated the notes Baa1 and BBB, respectively.

In July, Burlington Northern reported operating earnings of $1.18 per share, down 12% year over year. The current economic slowdown is having a deleterious impact on volumes, which fell 13% during the quarter. However, strong utility demand is expected to boost revenue going forward. We maintain a Neutral recommendation on the shares.

At least that’s what a new Barclays Global Investors study reveals. The research team led by Deborah Fuhr found that total U.S. assets in the ETF market hit an all-time high of $582 billion at the end of the second quarter, its highest mark since December 2007.

Interestingly, however, the number of U.S. ETFs, pegged at 706 from some 22 providers on three exchanges, is smaller than its European counterparts, which account for 753 ETFs for assets estimated at $183 billion.

According to Barclays, U.S. ETF assets have risen by more than 17 percent on the year – which is more than the 10 percent rise seen in the MSCI U.S. Index in dollar terms in the same period – but it’s particularly notable when compared to the modest 1.1 percent rise in the number of new ETF launches.

While assets bloomed significantly, average daily trading volume in U.S. dollars dropped 26 percent on the year to an estimated $57 billion.

Globally, total ETF assets ballooned to $857.5 billion by the end of the quarter, exceeding for the first time since 2007 its highest mark of $796.7 billion reached that year.

Topping the list with most assets under management worldwide was the SPDR S&P 500 (NYSEArca: SPY), with a total of roughly $69.38 billion.

The ETF, which turned 16 years old this year, has grown to be the largest ETF globally and the most liquid equity security traded in the world.

The findings by Fuhr are essentially in line with other end-of-August data compiled by the National Stock Exchange and SSgA. (See full story here.)

But what really sticks out is that despite some nice growth numbers in the U.S., the rest of the world keeps pumping up the volume on its ETF activity even more.

In the latest BGI research, Fuhr’s numbers show that:

• Globally, ETF assets jumped some 25.3 percent by the end of August. That’s more than 3 percentage points better than the U.S. this year.
• Europe (34.7 percent), Asia ex-Japan (39.1 percent) and Latin America (35.4 percent) all are handily surpassing the U.S. asset growth rate in 2009.
• Japan is the lone laggard at -6.9 percent ETF asset losses for the year.

At the same time, Fuhr’s data indicate that average expense ratios between ETFs in Europe and the U.S. aren’t all that different, broadly speaking.

On the low side, European ETF providers charge around 0.19 percent for currency funds and 0.16 percent for a typical bond portfolio. For regional exposure similar to what we’d think about in the U.S. as domestic index-tracking ETFs, investors in Europe average paying expense ratios of between 0.23 percent (for euro zone stocks) and 0.35 percent (across a wider assortment of European companies).

For U.S. stock exposure, European ETF investors are paying ERs of around 0.38 percent. But, to own commodity funds (0.45 percent), alternative-types of ETFs (0.65 percent) and emerging markets stocks (0.63 percent), it gets a little more expensive. (To gain U.S. sector exposure, Europe’s providers charge around 0.72 percent for their ETFs.)

That’s not too much more than ETF expense ratio rates in the U.S. But the big difference comes when comparing how much a mutual fund investor must pay on the two continents.

In Europe, an actively managed stock mutual fund focused on domestic stocks will run you an average of 1.75 percent. And an actively managed international equity mutual fund typically assesses ERs of around 1.73 percent.  Over here, investors are charged an average 1.41 percent for domestic-focused, actively managed mutual funds while the ER for international funds is 1.56 percent.

As my colleague Murray Coleman points out in a blog for our sister European site, it’s likely many of the new converts to ETFs overseas are diversifying away from all-stock portfolios.

Yet, with such an expense differential between mutual funds and ETFs still existing in developed markets like Europe, it’s no wonder that experts foresee higher growth rates for ETF assets in other parts of the world.

Although a lot of work still needs to be done on ERs domestically, BGI’s latest report shows that U.S. fund investors are still relatively fortunate – at least compared to what they’re getting docked to own mutual funds in other countries.

Cinthia Murphy is associate editor at IndexUniverse.com. She welcomes comments and suggestions for future blogs at: cmurphy@indexuniverse.com.

Last December, P&G had announced its intention to restrict making new investments in the pharmaceutical division and divest its interest in the healthcare brands. It decided to focus more on over-the-counter products such as Pepto Bismol, Prilosec, Vicks cough medicines and other personal care brands. Management stated that the pressure from generics was also one of the reasons for it to consider divestiture of this business.

Earlier in fiscal 2008, P&G sold its Folgers coffee business to J.M. Smucker Inc. (SJM) and added beauty and grooming businesses to its portfolio. The company’s prescription drugs division comprises products such as Actonel for osteoporosis (which generates more than $1 billion in revenue) and Enablex for the treatment of overactive bladder.

Warner Chilcott, which makes birth control, female hormone therapies and dermatological products, believes this acquisition will be a strategic fit to its existing business. The deal is expected to expand its market share in the women’s health market. Warner Chilcott will run the newly acquired business as its 100% subsidiary.

Private equity firm Cerberus Capital Management and drug maker Forest Laboratories (FRX) had also shown their interest in purchasing P&G’s prescription drug business.

Six banks, including Bank of America Corp. (BAC), JPMorgan Chase & Co. (JPM), Credit Suisse (CS), Citigroup (C), Morgan Stanley (MS) and Barclays (BCS) are expected to provide about $4 billion in financing for the deal. Out of this, Warner Chilcott will use $3 billion for the acquisition and the remaining $1 billion for refinancing its existing debt.

The deal is the largest leveraged loan transaction so far this year, providing an indication of reviving credit markets and a positive development in the loan market, especially after the collapse of Lehman Brothers.

Pimco is set to launch its second exchange-traded fund on Monday, again sticking with short-term Treasuries.

This time, however, the world’s biggest bond fund manager is moving into Treasury Inflation-Protected Securities. It’s a market with two entrenched competitors already vying for investment dollars. But TIPS have been hot attractions so far this year, and if inflation hawks are correct, could heat up even more in coming years.

New Competition

The Pimco 1-5 Year U.S. TIPS Index Fund (NYSE Arca: STPZ) will be the first to focus on the short-end of the yield curve. The two others already on the market take an intermediate tilt: the iShares Barclays TIPS Bond Fund (NYSEArca: TIP) and the SPDR Barclays Capital TIPS ETF (NYSEArca: IPE).

State Street Global Advisors also sponsors a global TIPS ETF, the SPDR DB International Government Inflation-Protected Bond ETF (NYSEArca: WIP). It has a longer duration than TIPS and IPE, which are hovering around eight years right now; WIP is listed with an average adjusted rate of slightly more than nine years.

The average duration of STPZ is about three years, according to Tammie Arnold, head of Pimco’s global wealth management group. She noted that short-term TIPS have produced higher correlations to inflation in the past five years (about 27% for STPZ’s underlying index and 6% for the broader TIPS market).

“Our short-term TIPS ETF is designed to be a more pure-play inflation-protection investment. It should expose investors to fewer of the risks associated with rising interest rates than longer-term TIPS funds,” Arnold added in an interview from the firm’s headquarters in Newport Beach, Calif.

All three U.S. TIPS ETFs are priced similarly: STPZ and TIP at 0.20% each with IPE at 0.18%. On the international side, WIP is charging 0.50%. Also, the 30-day SEC yields for TIP and IPE are around 1.50% while WIP’s is at 1.82%.

Different Index, Same TIPS Focus

The new STPZ will follow a Merrill Lynch index rather than the Barclays benchmark preferred by TIP and IPE.

Pimco’s John Cavalieri, however, downplays the significance of using a different index considering the rather limited number of U.S. TIPS issues actually available—roughly around 30 at any given time.

“The real key is the maturity segmentation of our index,” said Cavalieri, a Pimco senior vice president and real return product manager. “The other TIPS ETFs on the market cover the broader spectrum of TIPS available, including intermediate- and long-term issues.”

Despite deflation remaining a force in the U.S. economy, investors are still concerned about rising oil and commodities prices and looming federal budget deficits. A common investment theme has been to buy TIPS, with their built-in inflation protection, when the cost of such insurance is relatively low.

As a result, TIP has had the largest cash inflows into any fixed-income ETF this year. (See related research here.)

“We think this [STPZ] is a real sweet-spot type of product right now,” said Cavalieri. “By focusing on the short end of the maturity curve, we’re addressing the two main concerns we’ve heard from investors.”

Those are: inflation protection and protection against the risk of rising interest rates, he added. While other ETFs can provide the former, Cavalieri points out that STPZ is uniquely positioned to fight the latter.

“It boils down to this ETF providing exposure to the short end of the maturity curve, which limits interest rate sensitivity, which is commonly referred to as a fund’s duration,” he noted.

Two More TIPS ETFs Coming From Pimco

Pimco, the world’s largest bond fund manager by assets, is also planning to come out with two other TIPS ETFs. By early next month, it’s expecting to fill out the firm’s U.S.-focused TIPS lineup with: The Pimco Broad U.S. TIPS Index Fund (TIPZ) and the Pimco 15+ Year U.S. TIPS Index Fund (LTPZ). Both will also be tied to Merrill Lynch benchmarks.

In early June, the firm managing more fixed-income assets than anyone else came out with its first ETF, the Pimco 1-3 Year U.S. Treasury Index Fund (NYSEArca: TUZ). That was a change of pace for Pimco, which had planned to make an intermediate-termed bond ETF its first entry into the market. But with interest rates still at historically low levels, it shifted tactics and decided to introduce TUZ instead. (See related story here.)

Fidelity Investments already has its toe into the exchange-traded funds market. Apparently, that's about as far as it's willing to go, at least for now.

The president of the Boston-based mutual funds giant, known for its star manager system, let it be known last week that he was seeking a replacement. In the course of giving interviews to papers and news wires, the executive -- Rodger Lawson -- also made it clear that the firm was never interested in ETF's dominant player, Barclays Global Investors, when it was put on the market.

That led Sue Asci of InvestmentNews to ask Fidelity representative directly if the company wasn't going to pursue expanding its ETF presence. “We have no current plans to expand proprietary ETFs,” Fidelity spokesman Vin Loporchio told the magazine. (You can read the full story here.)

In 2003, the firm introduced its lone ETF, the Fidelity Nasdaq Composite Index ETF (NasdaqGM: ONEQ). With the explosive growth of ETFs and last year's record outflows from mutual funds, Fidelity has become increasingly tied to smaller ETF sponsors such as WisdomTree Investments.

Earlier this month, IndexUniverse.com reported that sources familiar with the situation had placed a team of Fidelity executives meeting with Wall Street investment bankers and key brokerage houses exploring the possibility of making a full-scale move into ETFs. (See story here.)

At the time, IU.com also talked to knowledgeable industry veterans who questioned whether Fidelity could overcome the expected objections from some of its star managers about the increased transparency issues presented by ETFs. It seemed unlikely, according to our sources, that Fidelity would be interested in a strictly passive, index-based family of ETFs.

Competitive obstacles were also a big reason why many analysts questioned how much of a force active ETFs would prove to be in the market. The partnership between Grail Advisors and American Beacon earlier this year touted the creation of the industry's first qualitative active mutual fund (i.e., one that feels and acts like a traditional fundamental-based mutual fund).

But it utilizes a team management approach, something that would go against the Fidelity style (although there are certainly some exceptions to that rule).

Did transparency kill the deal with Fidelity? Other issues also appeared to loom on the horizon, but the current regulatory environment and competitive landscape would also seem to figure into the equation.

At the time of our last report, we also heard that if Fidelity moved forward it would probably have to push for advancement of so-called "black-box" formulas. Those methodologies essentially ask the Securities and Exchange Commission to relax guidelines on daily reporting of holdings to let managers provide a sample portfolio -- not the whole enchilada.

So far, we haven't heard of any advancement in the SEC's green-lighting of such practices. So the next big issue facing Fidelity might come down to whether its decision is permanent. Or, if regulators wind-up approving some sort of actively managed process that allows for partial non-disclosure, will Fidelity reconsider its decision to stick with traditional mutual funds?

ETF Securities made a big splash with its new silver fund, SIVR. Next up on its wish list are funds focusing on gold, platinum and palladium.

William Rhind is head of sales and marketing at ETFS Marketing LLC, the U.S. arm of London-based ETF Securities. The U.S. unit opened operations in July with the launch of its first exchange-traded fund, the ETFS Silver Trust (NYSEArca: SIVR).

The former iShares executive for Barclays Global Investors’ European operations recently discussed with IndexUniverse.com’s Murray Coleman plans by ETFS to expand in the U.S. marketplace.

IU: Has a move into the U.S. been something that ETFS has been considering for awhile?

Rhind: Our chairman, Graham Tuckwell, invented the gold ETF in 2003 and launched the first gold ETF in Australia. The first ETF in the U.S., the SPDR Gold Shares (NYSEArca: GLD), was made possible by the structure invented by Graham. After launching the first gold product, ETF Securities was established in 2005, and we built the largest exchange-traded commodities business in Europe.

IU: And that led you to the U.S.?

Rhind: Yes. When you get to the size we are now, we feel very strongly that we want to be the leading provider of exchange-traded commodities products in the world. The natural extension to our franchise in Europe is to expand into the U.S.

We think the U.S. equity ETF market is very competitive and arguably very saturated. But we feel that the U.S. commodities marketplace is under-served. We want to set new standards for transparency and education and service in the U.S. commodity ETF market and see ample opportunities for future expansion.

IU: What areas could those expansion plans lead to in terms of new types of products?

Rhind: At the moment, if you look at our filings with the SEC, you can see that we’re initially planning on launching precious metals products in the U.S. (See full story here.) In Europe, we essentially offer all types of commodities products from single commodities to baskets and indices. In the U.S., we’d like to at least offer a subset of those products here initially.

IU: Specifically, what else is in your U.S. pipeline?

Rhind: We recently launched the ETFS Silver Trust. (See related story here.) SIVR is designed to track the price of silver, less the associated expenses. SIVR has been very well received in the U.S. and now has assets under management of over $85 million. We have also filed for gold, platinum and palladium. The palladium exchange-traded product would be the first of its kind in the U.S.

That would be true with the platinum as well. The gold product will compete against GLD. We’re still in the registration period, so I can’t say too much other than what is publically available, but the key difference is that the gold will be stored in Switzerland rather than the U.S. or London, as GLD does. By having a product vaulted in Switzerland, it removes concerns about the nationalization of gold as a product in the U.S. In 1933, the U.S. government confiscated personal holdings of gold through a special presidential order.

IU: Isn’t your existing European gold ETF stored in London?

Rhind: Yes, by providing two separate gold ETFs, we’re allowing for more diversification on the part of investors worldwide.

IU: The gold ETF is going to use J.P. Morgan as the head custodian. Why not appoint a Swiss custodian directly?

Rhind: Essentially, they’re a large precious metals custodian with tremendous resources to handle a large-scale global business. So we believe that scalability is going to be important. We want to work with someone who can facilitate the business as it grows, and J.P. Morgan is a partner who can provide that.

IU: How do you view the regulatory environment for commodities investing in the U.S.?

Rhind: The CFTC is investigating behavior in certain futures markets. But the commodity market as a whole continues to function the way it always has. When it comes to commodity ETFs, there has been some scrutiny on some of the energy products that utilize futures contracts. However, the SEC just approved issuance of additional shares for UNG [U.S. Natural Gas Fund] which is a positive step for the industry.

I think the majority of people recognize that ETF or index investors are generally long-term investors by nature. They want transparency, liquidity and stability in markets. Overall, we feel there is a positive regulatory environment in the U.S. for new commodity ETFs. People accept and understand physical asset-backed commodities funds like gold or silver, and the return profile is easy to understand. After all, gold funds actually physically hold bullion and silver funds like SIVR actually holds silver bullion.

IU: Commodities are still just a small portion of most investment portfolios, aren’t they?

Rhind: Correct, but they’ve been becoming ever larger, especially during the past 12 months. Traditionally, people have been allocating 2-3% to commodities. But we’ve been seeing in some places that now up to 5-8%. That’s one area of growth in the U.S. market for us. And naturally, there are going to be more products as we broaden our fund offerings. People will be able to allocate to different commodities in different sectors. A pension fund, for example, probably wants to hold a broadly diversified commodities ETF.

As we build our business, we’re certainly going to have more than just precious metal funds. We want to develop a one-stop shop where investors can come and find any type of commodity investment they’d like. That’s what we have in Europe, with about $12.5 billion in assets under management. We’ve got more than 130 ETFs worldwide. We firmly believe the U.S. business could be bigger than the European business.

IU: In Europe, you’re mainly focused on commodities. But you’ve also been branching into different asset classes, haven’t you?

Rhind: Yes, and it has only been within the past several months. That’s a very new business for us and represents about $200 million of our total assets. But we want to build the biggest and best business in the U.S. Right now, we’re just focused on building our commodity business in the U.S. However, we reserve the right to expand into other asset classes at some point. But for right now, we want to become the No. 1 provider of commodity ETFs in this market.

(Editor's note: This story also appears on IndexUniverse.com's sister European site here.)

The Dow Jones industrial average added 37 points, or 0.4%, and closed at its highest point since November 4.  The broad S&P 500 index added 7 points, or 0.7%, and closed at its highest level since October 6.  The tech-heavy Nasdaq gained 10.63 points, or 0.5%, ending at its highest point since October 1.  On the New York Stock Exchange 776 million shares exchanged hands and advancing stocks outpaced those that fell two to one.  The Vix "fear factor" index, fell 2.9% to 24.71.

Treasury prices rose after an auction of $15 billion 30-year bonds met with strong demand.  The 30-year rose 1 20/32 in price and its yield declined to 4.432%; the 10-year was up 30/32 in price as its yield declined to 3.604%. This week the government issued a total of $75 billion of debt. 

Financials led the gainers yesterday on news that John Paulson’s hedge fund bought stakes in Bank of America (NYSE:BAC).  Bank of America shares surged 6.7% to $17 and were the leading gainers on the DJIA.  Basic material shares rose 2.7%.  On the DJIA Alcoa (NYSE:AA) shares gained 5.8%.  An increase in metal prices sent shares of Freeport McMoran (NYSE:FCX) up 4.9% and Newmont Mining (NYSE:NEM) 2.5%.  Ford (NYSE:F) shares increased 2.6% on its announced plans to increase current quarter production by 100,000 vehicles, with additions to the fourth quarter as well.

Technology shares advanced 1%.  Barclay's (NYSE:BCS) raised its price target on Apple (NASDAQ:APPL) shares to $208, citing its product pipeline. JP Morgan (NYSE:JPM) raised its price targets for Dell (NASDAQ:DELL) to $13 from $10 and Hewlett-Packard (NYSE:HPQ) to $49.50 from $40.

Nevertheless, consumer spending, which accounts for a whopping 70% of the US economy, remains a concern.  Yesterday’s report which showed a surprise 0.1% fall in retail sales, versus estimates of a 0.8% growth, did raise some doubts on demand side growth assumptions from the consumer sector.  The drop indicated that the "cash for clunkers" program may have stolen from alternative purchases and perhaps from future purchases as well.

How broad-based of an audience can an exchange-traded fund focused solely on companies based in Peru attract?

Since launching a little more than a month ago, the seemingly narrow-focused iShares MSCI All Peru Capped Index Fund (NYSEArca: EPU) has seen its assets top $33 million. That’s actually down a bit from a week ago when that number surpassed $35 million. (See related story here.)

So what’s driving such growth? Performance is one factor. In the past month, EPU’s returns have shot up by nearly 4 percentage points. More significantly to longer-term investors, the country has produced the best gross domestic product growth rate in the region—or near the top, depending on periods studied and data used—for more than a decade now.

And even more assets figure to start flowing EPU’s way. Shortly after coming out on June 22 (see related story here), iShares’ parent Barclays Global Investors announced that Peru’s pension fund manager has decided to invest some $300 million into the ETF over the next several months as a way to create more liquid and diversified portfolios for their investors.

It’s a theme that Daniel Gamba, BGI’s executive director of Latin American operations, says he’s seeing spread throughout the region.

IndexUniverse.com Editor Murray Coleman caught up with him at BGI’s headquarters in San Francisco on Thursday for a discussion of the growth of ETFs in Latin America. Below are excerpts from that conversation.

IU:  How much growth are you seeing in single-country Latin American ETFs?

Gamba: The asset base for EPU since it launched in June has been growing. It was actually seeded with about $1.2 million in assets. The markets have come down in the past few days a little, but the fact that it has been growing by about $2 million a day make us fairly optimistic. The expectation is that EPU will continue to grow at least at that pace in the future. And Peru is within the top two Latin American markets currently being recommended by U.S. analysts.

IU: In the U.S., a single-country ETF like EPU might seem like a niche product. But last year, Peru’s GDP grew at a 9% rate and it’s still Latin America’s fastest-growing economy, isn’t it?

Gamba: Yes, and we’ve seen strong relative growth in that country for several years. Between 2002 through 2008, its GDP growth averaged 6.8%. That was larger than Brazil or any other country in Latin America. And the inflation rate in Peru continues to be one of the lowest in the region.

IU: Do you see more pension managers in other countries investing in ETFs?

Gamba: In Latin America, pension plans are starting to use ETFs more these days. In Chile, pension plans have about $100 billion in assets, of which around $5 billion are invested through ETFs. Our market share represents roughly 80% of those pension ETF assets. In Mexico, the total pension system is about $100 billion, with ETF pension plan assets of around $7 billion. And Peru’s pension portfolios have close to $25 billion total assets, with about $1 billion in ETFs. As a whole, our ETF market share is about 80-90% throughout Latin America.

IU: How about Brazil?

Gamba: We just listed local ETFs in Brazil at the end of last year. We currently have about $1.5 billion in assets through the local exchange. But across Latin America, there’s a big trend of pension plans moving into ETFs as a more liquid way to diversify their existing portfolios.

IU: Isn’t the Latin American pension plan model being used in other parts of the world?

Gamba: Yes, and as a result, we’re seeing ETFs being embraced in regions such as eastern Europe. Those countries are using a similar type of pension system to the one in Chile. That’s also the case in Latin America, which has also closely followed the model pioneered in Chile.

IU: What similarities do these pension systems share?

Gamba: Basically, we’re talking about a shared view that pension systems should obligate employees to contribute at least a certain percentage of their salaries. Then a group of select pension fund managers handle those assets. It’s similar to the U.S. 401(k) system, except in Latin America and eastern Europe, contributions are mandatory. The ETF structure is being viewed as a favorite with regulators in both of those regions as a means to diversify and add more transparency into the pension systems.

IU: What do you expect for ETF growth rates in pension plans in the future?

Gamba: We expect pension plan assets in Latin America to grow at an average annual rate of around 15% over the next five years. The big majority of that growth will be driven by inflows from employees, who average 28-30 years of age across the region. And again, they’re obligated to contribute.

By contrast, in developed markets around the world, we’re seeing pension plans growing in single digits, less than 10% a year.

• This morning’s report indicate Amgen (NASDAQ:AMGN) and GlaxoSmithKline (NYSE:GSK) have agreed to jointly market an osteoporosis treatment, that could generate $2 billion in annual sales within ten years if given regulatory approval

• Barclays (NYSE:BCS) cut Boeing (NYSE:BA) shares to "equal weight" from "overweight", on delays and undetermined cost overruns in its Dreamliner program. Price targets were cut from $60 to $46

• Goldman Sachs (NYSE:GS) raised its rating on the US steel sector to "buy" from "neutral," noting a faster-than-expected recovery in world markets and a leaner US supply chain. Analysts upgraded US Steel (NYSE:X) in advance of today's earnings release to "buy" from "neutral" with a $52 price target

• Reports said IBM (NYSE:IBM) plans to acquire SPSS (NASDAQ:SPSS) in an all-cash deal valued at $50 per share

• Under Armour (NYSE:UA) reported second quarter earnings of 2 cents per share, one cent above estimates, on a 5.1% revenue advance to $164.7 million, topping Street estimates of $159.1 million. The firm said it sees 2009 earnings of 80-82 cents a share, versus estimates of 79 cents, with revenues of about $810 million, up from estimates of $804.85

• JP Morgan (NYSE:JPM) upgraded shares of Air Products and Chemicals (NYSE:APD) to "overweight" from "neutral"

Company Description

BlackRock is an investment management company that specializes in risk management and advisory services. The company manages to institutional and individual clients and has a market cap of $24 billion.

BlackRock reported second-quarter results on July 21 that were ahead of estimates and a big improvement from the first quarter.

Second-Quarter Results

Revenue was down 26% from last year to $1.03 billion, but earnings bested expectations, coming in at $1.75 when removing one-time items, 24 cents ahead of the consensus.

The drop in revenue was related to BlackRock's investment and advisory fees, which were down 27% to $850 million. Earnings however showed a nice improvement from last quarter's 81 cents, a reflection of the improving fundamentals of the financial industry.

BlackRock Acquires ETF Business

BlackRock has also recently expanded its business, announcing on June 16 that Barclays had accepted its bid to acquire the company's lucrative and market-leading ETF business for $13.5 billion. The deal has yet to officially close, but Barclays is recommending its shareholders approve.

Estimates Up

Estimates have been steadily rising with the company's share price over the last few months, with the current year adding 50 cents and climbing to $5.64 per share. The next-year estimate is bullish, projecting 38% earnings growth.

Valuation

Based upon the current-year estimate, this stock has a P/E multiple of 31X, a steep premium to the overall market.

The Chart

As previously mentioned, shares of BLK are up big after bottoming just above $90 in early March. Since then, shares have more than doubled in value, topping off above $180. Take a look below.

Zacks Investment Research

• Goldman Sachs (NYSE:GS) downgraded shares of IBM (NYSE:IBM) to "neutral" from "buy"

• Infosys Technologies (NASDAQ:INFY) beat estimates by 8 cents, posting fiscal first-quarter earnings of 55 cents a share as revenues fell 2.9% y/y to $1.12 billion.  The company expects second quarter earnings of 50 cents to 51 cents a share and full-year earnings of $1.97 to $2.00

• Barclays (NYSE:BCS) upgraded KLA Tencor (NASDAQ:KLAC) shares to "overweight"

• General Motors (NASDAQ"GMGMQ) exits bankruptcy today

• Nissan Motor (NASDAQ:NSANY) CEO Ghosn warned 2010 is likely to prove "as difficult as 2009," with Europe expected among the slowest areas to recover worldwide

• Credit Suisse (NYSE:CS) upgraded Western Union (NYSE:WU) shares to "outperform" from "neutral"

• Citigroup (NYSE:C) warned AIG (NYSE:AIG) investors may have little left after the US government is paid back. JP Morgan (NYSE:JPM) has opted for a public determination of its warrants' valuation in order to pay back government borrowings

• BMO Capital noted mildly positive data for May from Las Vegas Strip gaming revenues

The Dow Jones industrial average closed at its lowest level since April 28, plunging 161 points, or 1.9%, to close at 8,163.60.  Among DJIA components, only four managed to register gains yesterday.  The S&P 500 index dropped below its 200-day moving average, losing 18 points or 2%, to close at its lowest point since May 1.  The Nasdaq declined 41 points, or 2.3%, to close at 1,746.17, its lowest close since May 27.  Declining shares outran advancing issues on the NYSE by a four-to-one margin as trading remained seasonally light.

All ten industry groups on the S&P 500 ended lower, with only defensive areas of consumer goods and healthcare recording declines of less than 2%.  Oil and gas issues fell 2.6% and technology stocks declined 2.5% as a number of ratings upgrades were ignored by traders. Industrials led the decliners with a 3.2% fall on concerns that the recent rally has gone ahead of any economic recovery. 

Alcoa (NYSE:AA), which reports its earnings after today’s close, tried to brush aside analyst worries, advising it was optimistic about its sales, as the Chinese economy and US automotive industry begin to recover. Barclays (NYSE:BCS) raised its price targets on Exxon Mobil (NYSE:XOM) and Murphy Oil (NYSE:MUR). Furthermore, traders will look toward this week's US and the International Energy Agency updates on demand forecasts, looking for indications of stabilization in their downward revisions.

According to Thomson Reuters (NYSE:TRI), analysts have lowered their second quarter earnings expectations to a 35.5% decline, inline with first quarter results.  Basic material shares are expected to register a 79% earnings decline, versus a year ago, while energy companies are expected to report a 65% slide and financials a 53% drop.

Bank of America/Merrill (NYSE:BAC) also raised its ratings on a number of semiconductor shares, including Intel (NASDAQ:INTC), noting recent macro trends suggest a "definitive turn in end demand." But Gartner Inc predicted a 6% fall-off in information technology this year. Financial stocks, however, are expected to face turbulence as a cautious Deutsche Bank (NYSE:DB) report estimates credit pressures likely to result in losses at ten of the sixteen banks covered.  The report also estimates losses for the second half of 2009 and much of 2010.  KeyCorp (NYSE:KEY), Marshall and Ilsley (NYSE:MI), SunTrust (NYSE:STI) and Zion Bancorp (NASDAQ:ZION) may show the weakest results.  However, Wells Fargo (NYSE:WFC) is expected to benefit from strength in its mortgage and trading operations; Meanwhile, KBW upgraded KeyCorp (NYSE:KEY) shares noting the bank has now exceeded Treasury requirements following its capital raising.

Today's calendar covers a G8 summit without Chinese President Hu Jintao who has rushed back home to attend to the Xinjiang crisis. Other items include the weekly MBA mortgage applications post, a 10.9% weekly gain, EIA Petroleum statistics, and consumer credit.

Dubai Exchange Benefits From Oil's Improved Fortunes

The exchange's chairman credited the uptick to positive market sentiment for oil and a move by the "Dubai Department of Petroleum Affairs to shift to a forward pricing model based on the DME Oman Crude Oil Futures Contract."

You can read the exchange's press release here.

Questions For BlackRock

Scott Burns of Morningstar has some interesting questions for BlackRock as it prepares to swallow Barclays Global Investors and its popular iShares brand.

Among them: What does it mean for iShares investors and what designs does the active management firm have for the ETF marketplace?

(He notes in the article that iPath ETNs aren't included in the deal. Wonder where he got that?)

You can read the story here.

BOX Going For The Gusto

The Wall Street Journal reports that the Boston Options Exchange is eliminating fees for three popular ETFs. It's the start of an effort by BOX to increase its market share in the expanding options business.

It's also a nod to the significant role of ETFs among investors using such strategies.

You can read the story here.

Changes To Money Market Funds

The Securities and Exchange Commission is expected today to announce its plans to reform money market funds. It'll be interesting to see how that might impact ETFs, which up to now haven't been able to designate themselves in such a fashion due to existing—and some would say outmoded—rules.

A MarketWatch.com account by Sam Mamudi previewing the news can be found here.

As part of the festivities surrounding the 2009 Journal of Indexes editorial board meeting, IndexUniverse.com hosted a live webinar with Vanguard founder and index industry legend John Bogle.

During the one-hour presentation, Mr. Bogle unveiled new research regarding how successful (or not) investors are when trading exchange-traded funds, and took a big picture look at the state of American finance.

Moderated by JoI editor and IndexUniverse.com publisher Jim Wiandt, the webinar features an extensive audience Q&A session. A full transcript follows below.

Jim Wiandt, editor, Journal of Indexes (Wiandt): Good morning everyone, and welcome to a very special event that we have here today. We are actually at the NASDAQ market site and we have the Journal of Indexes editorial board meeting today.

We have a very special guest to present today at our webinar. John Bogle is a legend. He is an icon and is really the father of indexing and sensible asset allocation for average investors. We are delighted to have Mr. Bogle here today.

He is going to go through a series of slides, some of which are extremely interesting and very pertinent, which speak to the way the index industry has evolved in recent years.

The format for today will be first, Mr. Bogle will go through his slides, and then we are going to open things up for questions.

We have all of these slides posted to our Web site, IndexUniverse.com [available here]. Without any further ado, I will turn things over to Mr. Bogle. And, again, we are delighted to have you, Mr. Bogle, and look forward to the presentation.

[Editor’s Note: A replay of the webinar is available here.]

John Bogle, Bogle Financial Markets Center (Bogle): Thank you very much, Jim. And welcome, all you webinar listeners. I presume there are a few Bogle-heads there and I send a special welcome to them.

It’s fun to be with you this morning. I thought I would begin by giving you a report on the status of index funds in mid-2009. I guess the main point I would like to begin with is that we now know what we really suspected, or strongly believed, 25 or 35 years ago when I started the first index fund—that indexing would change the world of investing.

I believe it is now clear that indexing has changed the world of investing in some very remarkable ways. First and most notably, I think we’ve had an odd convergence of indexing in two different areas. Active fund management has become much more like passive fund management—for example, active managers are often quantitative, working off matching indexes or having enhanced index funds or closet index funds. Or when you look at brokerage recommendations, you see they overweight relative to the index or underweight rather than buy or sell. The way we look at investing has been changed by standard indexing.

But even as that has happened, passive indexing has gotten a lot more like active fund management. That is, we use index funds for rapid trading in some very remarkable ways, which I will discuss this morning.

We can go to the first slide there and just take a look at what I will call a triumph of indexing. You see the growth of indexing just in the last 15 years from $24 billion to $914 billion on the equity fund side. Throw in roughly $150 billion of bond fund indexing and you are over $1 trillion—about $1.60 trillion in index money in a long-term stock and bond mutual fund industry that has $6 trillion of assets. So indexing itself now accounts for one-sixth of all the mutual fund assets; quite a remarkable thing.

And so, it’s pretty nice to think that last year, 2008, is probably the best year indexing ever had in terms of performance. For the total stock market and the S&P 500—two good proxies for what is going on in the U.S. market—indexes of those two components put them in about the 65^th percentile [of overall fund performance], outperforming about two-thirds of all mutual fund managers. Sure, the decline was about 37%, but the typical U.S. manager went down about 40%; the typical developed market fund went down about 45 to 50%; and the typical emerging market fund went down 55 to 60%. So on the stock fund side, it was quite a triumph for indexing.

On the bond index fund side, it was even more of a triumph. The total bond market index was up 5% last year, outperforming about 85% of comparable bond funds, thanks largely to a big drop, as most of you may know, in Treasury yield.

So we’ve got this wonderful growth rate. We’ve got a dominant industry position. And yet, some unusual things are happening. We will take a look at what is driving the growth of indexing by looking first at ETFs—exchange-traded index funds. And as the next chart shows, I describe them as a truly great business model. Hear carefully when I say “business model.” We will talk about other kinds of models later on.

You can see in the next chart that ETFs have come from almost nowhere—back in the early 1990s, when the first exchange-traded fund was started—to the fact that they are now actually just a hair behind in terms of equity fund assets the traditional index funds, the kind of funds that Vanguard pretty much runs: $457 billion compared to $460 billion, or $456 billion plus. So the ETFs have proved great competition for the classic index funds, basically what I thought about all those years ago.

I’m often asked, “Who is going to win the war: mutual funds or exchange-traded funds?” That is not a good question, because exchange-traded funds are mutual funds. They are just mutual funds you can trade all day long in real time. We will talk a little bit about that. So what we have is, what is growing is index funds for people who want to trade or who believe that the opportunity to trade or the ability to trade is important, intraday trading; and equity mutual funds, which are more designed for long-term investors.

But going over to the next chart, you will see pretty much what has driven the growth of index funds even more clearly than the previous chart. Exchange-traded funds were about 2% of the index fund business back in about 1997, 1998. By 2000, they got up to about 11%. In 2008-2009, they are 11% of equity fund assets, just exactly the same, almost exactly the same as the 11% in traditional index funds.

So we have had a huge growth rate for ETFs. And in terms of market share, stability in a lot of ways, and maybe disappointing stability in the market share of traditional, classic index funds—old, broad market index funds. But for quite a few years, the cash flow went very much in favor of … active funds over index funds for years and years.

But in 2007, as you can see in this chart, the index funds took in about twice as much in the way of assets as actively managed funds. Last year, index funds took in $200 billion in assets. Active funds lost $250 billion. And this year, index funds are taking in a little bit of money so far. These are annualized numbers for 2009. And the active funds are, again, losing so far, on an annualized basis, about $150 billion this year. So clearly, the trends are there. The trends are also there for traditional index funds versus exchange-traded funds.

You can see on this chart the dominance of exchange-traded funds has really been quite remarkable these last three or four years. Where the traditional index funds were taking $40 or $50 billion a year in net cash flow—a good measure of success in the marketplace—the exchange-traded funds were taking somewhere between $140 billion to $150 billion a year and three or four or five times as much. Whether this is a trend or not is much too early to say.

That has been somewhat reversed here in 2009 with, on an annualized basis, the traditional index funds actually adding about $40 billion, expected to add about $40 million in cash flow—where for the first time ever, exchange-traded funds are actually having cash outflow roughly in the amount of $30 billion annualized this year so far. Whether that is a turn in the tide, only time will tell.

Now, if exchange-traded funds are a brilliant business model, are they a good investment model or, as this next slide asks, are they a flawed investment model? And we know they are a good business model. We know they are great for fund marketers. We know they are great for brokers. We know they are great for investment advisers. We know they are great for institutional speculators. But the question is, what are ETFs doing for individual investors?

That is an interesting question and we have done some research on it, which we are going to unveil here in a little bit for the first time. I come back now to the difference between an exchange-traded fund and a traditional index fund. An exchange-traded fund, to use the quotation from the original ad for the SPDR [NYSE Arca: SPY]: “And now you can trade the market all day long in real time.” That is what the original SPDR was advertised as doing. I’m not exactly sure why anybody would want to trade the market all day long in real time, but that is their slogan.

In many respects, as this chart shows, that idea of using ETFs, exchange-traded funds, for speculation has come true, come more than true, come true in spades. You can look at it any way you want, but look at those turnover rates for share turnover in the SPDRs there. And they are in second: 10,105% turnover last year. Just think of that. There are about 711 million shares outstanding of the SPDRS and they have 8 billion shares traded last year―8 billion shares of SPDRS traded.

And that doesn’t seem to be particularly good, even for those investors. Because while the SPDR had a five-year return of -1.9% a year—it’s been a difficult market—the average investor in SPDRs had a return of -8.2% a year. So you tell me whether all that trading is good for investors or is not good for investors. You can see what you would expect.

On the other more speculative side of the markets, the ETFs trades very heavily. Real estate funds have huge ups and downs. The turnover of the iShares real estate ETF we looked at was 23,977%—to put precision on a number that doesn’t need to be precise.

Obviously, Financial SPDRS were attractive both to buyers and sellers last year, with 9,600% turnover. The NASDAQ QQQs? 8,700%. These are remarkable numbers, suggesting that a great deal of what’s going on in ETFs is a business of very rapid trading among large, institutional investors.

Now, when you look at more normal share turnover, over on the right side of the chart—we just took out of a group of about 38 or 40 funds, the lowest turnover funds. More than about half of them seemed to be Vanguard funds, which have turnover in the range of about 200% per year, far lower than those high percentages. So there is a use for ETFs that doesn’t require the trading that seems to show up in the less speculative part of the market.

How high is a 200% turnover rate? Well, the average mutual fund last year happened to have one of the highest turnover rates in a long time—a 33% redemption rate last year. That’s high, very high as far as I’m concerned. So you can imagine what I think of 200% turnover.

What we are seeing here is the use of funds, of ETFs, for speculation. For the bigger ones and for the more traditional ones, in some sense at least, we have much lower turnover, but still high compared to mutual fund turnover.

If we go to the next chart, we can try to answer the question on the next two charts. Okay, we know how ETFs do. But only in recent years have we found out how the investors in mutual funds do. You can actually calculate these returns, what we call the fund returns or the time-weighted return, or typical rate of return. Something starts at $10 and goes to $11―that’s 10%, not very complicated there. But then we do a dollar-weighted return, an asset-weighted return, to show how investor cash flows influence that return delivered by fund. The reality of life in this business is that it is very rare that investors do as well as the funds themselves.

And that is the point I’m making on this chart with the ETFs. These are all exchange-traded fund groups. You will be familiar with the groups: large-cap blend, large-cap growth and value, same in the mid-caps, European, emerging markets, and so on. And you will see that in general, investors lag those returns, just glancing at those numbers, by 5% or 6% a year of return. [That is, they earn] 5% or 6% less than the fund, than the ETF itself earns, showing that the trading is done in an unfortunate way in terms of timing.

The numbers shown over on the right side of this chart are unbelievably consistent. For example, on that page there are 46 ETFs, and in 40 cases out of 46, the investor returns lag the funds return. This is not an aberration. This is a very consistent return, which you will see again if we will flip over to the next chart, which just shows some additional subsectors of the market, in the ETF form, with the investor return and the investor lag.

You can see in some cases―the financial case, for example―the fund’s return trail the index return by almost 11% per year over the last five years. The investors had a negative return of almost 29% over the last five years, a lag in return of almost 18% a year. It is hard to believe. And there, 100% of the funds lag the index. So when you put those two charts together and add them up, out of 79 exchange-traded funds that we covered, 68 of them had investor returns that were either substantially, significantly, or moderately at least short of the returns earned by the funds themselves.

So if you want to take some kind of a simplified average and say that fund returns were generally negative to about 1% a year, and the investor returns on average were negative about 3.5% a year—I’m sorry. The fund returns happened to be positive, thanks to energy and utilities and emerging markets and such segments as that, just a simple average of positive 1%. You find the ETF returns averaged about 6% on these charts, accumulated over five years. But investor returns, if you take -3.5% with negative compounding over five years, investor returns were about -12%.

So when you put plus 6% for the five-year total return for the fund and -12% for the five-year total return for the investor, you are talking about 18% of investor capital that has been lost by all this trading. Now, you can ask, “Don’t regular mutual funds have this same problem of investor returns lagging the returns of the indexes or returns of the funds they own?” Of course they do, but it is not nearly as bad.

To show that, we will introduce one more chart, which I think will be the last chart I will use, so we can open it to your discussion. We happen to have Vanguard mutual funds that have ETFs, exchange-traded funds, in each of these categories. And we have compared the returns on the Vanguard mutual fund returns on this chart, beginning with large-cap blended funds, large-cap growth, large-cap value, mid-cap blended, small-cap blended, emerging markets and real estate investment trusts. We have a regular fund in those areas, Vanguard does: a regular mutual fund. Those returns are shown near the center section of the chart. And the investor returns on the exchange-traded funds are shown on the right side.

You will see that while the investor lag on the exchange-traded funds and side on the left have remarkably large and significant lags, the actual mutual funds themselves lag here and there, but in general, come very close to the returns earned by the market standard that they are in. So we have evidence, strong evidence, that exchange traded funds―because of the timing that goes on―are not acting in the best interest of investors, or investors are not acting in their own best interest, might be a fairer way to put it. While mutual fund investors have similar problems, they are nowhere near so serious. They are not even in the same league.

So the question I raise is―I suppose a broad, philosophical question―how long can a great business model last if it doesn’t deliver good returns to the investors who rely on it? And that is a question we might chat about. But first, before that, I would like to open the meeting and try to answer any questions any of you might have who were kind enough to attend this morning.

Wiandt: Thank you, Mr. Bogle. We have a lot of good questions. Why don’t we start out with one which talks about your methodology? There are a few questions in this area about how these returns are calculated. I guess the focus of these questions is, is most of this turnover retail turnover? Is it institutional? Is it both? And how did you come up with these calculations in terms of looking at the flows and calculating these returns?

Bogle: Well, first it is very hard to separate out institutional turnover, the huge turnover where people are speculating on, for example, the SPDRs. Investment adviser turnover, how big is that? How much is individual turnover by those who intend to invest and that other component of individual behavior, which is those that intend to speculate. I don't know anybody that has unscrambled that egg. I am not privy to Vanguard data on this point.

I think even more important would be the data that someone like Barclays could provide. They are, of course, the largest firm, the most dominant firm in this business with the broadest base of business. So we are just going to have to ask them how they would divide this up. I did have a conversation with a representative of Barclays three or four years ago, and I was making the same point I am making this morning. He said, “Well, that just is not right. Seventy percent of our investors are long-term investors.” And I said, “How do you define long-term?” And he said, “Six months to a year and a half.” Well, that is not my idea of a long-term investor. That is just another example of the difficulty of getting through. It is a matter of definition.

Now, as to the methodology, we don’t do these ourselves. These are Morningstar data. My understanding of how that data is compiled, and I take some comfort by the way, in its consistency from one group to the other—which suggests that there are not a lot of problems with the data. Although I’m the first one to state and underscore that all data has problems. When you see really consistent data like this, however, it’s an eye-opener. It may not be precise, but it’s got to be giving us an indication of what we know to be true.

One of my rules has always been, take a look at some numbers and if it flies in the face of your intuition, do the numbers over and over and over again. But if the numbers confirm your intuition―which is essentially that ETF shareholders and mutual fund shareholders generally look back at past performance and buy the funds that have done well―it is sort of performance-chasing…

We know that happens. We can’t measure it with precision.

Now when you get funds with a lot of daily cash flow in and out―I’m sure real estate REITs are a good example of that, and I’m sure the SPDR is a very, very good example of that―I don’t see how we can be precise in these returns. What you do is take monthly cash flows and compare them with the price of the fund, the average price of the fund during the month, then you figure out eventually how many investor dollars earn what returns over time. Is that way of aggregating the data precise? No, it is not.

But I’m persuaded in the absence of compelling evidence on the other side that these data are telling us something that is worth knowing. And it suggests that mutual fund trading is about as valuable as trading individual stocks, which is to say, not valuable at all, and harmful to your returns.

Wiandt: Every year we hear from active managers that “this is the year of active management.” Do you believe that there are environments that are more favorable to active management than passive management and index investing? And if so, what do those times look like?

Bogle: There is no way that active managers can possibly have an advantage no matter what the circumstances are. Just think about this: Almost 75% almost of all stocks are owned by institutional investors now, and they are basically, by and large, professional investors. They are pension fund investors. They are pension money managers, they are pension trustees I should say, pension money managers, mutual fund managers, which also manage pension funds and endowment funds. And that’s 75% of all stocks, and only 75% of all stocks. It is just not possible that they can be taking the individual investor on the other side— the remaining part of the market—to the cleaners with every trade. There is no evidence of that.

So what we find is that institutional investors and individual investors basically each capture the market return and they each capture the market—and together they each capture the total market return. That is inevitable. And that’s before cost. So when you take out costs, which are high, you end up explaining almost all the reasons that active managers cannot and do not beat the funds, beat the market itself. It is just statistically, mathematically, tautologically impossible.

Wiandt: How do you see the Barclays-Black Rock merger affecting the investment landscape? What do you view as the implications of that merger?

Bogle: Well, that’s a good question. I have a couple of observations. First, they paid a pretty good-sized price. I think since Barclays kept 20% of the company, the price comes out to be something like $17 billion or $18 billion. That’s a lot of money to pay for a fairly low-margin business. Second, ultimately, I think they are going to have to reduce the cost of the funds, which will make it less attractive as an investment—because they are just a very high-cost outfit, compared to the low-cost provider, which is always Vanguard.

iShares has an average expense ratio of 41 basis points. And those are the ETFs run by Barclays. Vanguard has an average expense ratio in its ETFs of 15 basis points. Eventually the low cost wins. That’s all there is to it. So they are going to have to worry about whether they can be able to be competitive with high prices—which can be providing them with a lot of revenues and maybe a lot of money to do marketing and a lot of money to create one new index-based ETF after another, which they seem to be doing.

I think it is going to be a hard business then to build market share. And since they are around a 50% market share now, in my experience, most firms, when they get to 50% market shares, find it much more likely for that market share to shrink than to grow.

There is also another kind of a subtle thing, and I don’t mean to be unkind at all to BlackRock, but they have a real problem with active management. There is no question they must be interested in index funds because they are indexed and not actively managed. We took a look at 100 funds. They have 100 closed-end bond funds and we took a look at them last year, and 99 of them—you know, the bond market went up 5%—99 of them had negative returns. Fifty-four of them had negative returns of over 20%, including 24 of the Black-Rock-managed bond funds that had negative returns of 30%–60% last year.

I mean you’ve got to be struggling with the business when active management is producing those kinds of returns on their bond funds, their area of expertise. So I wish them well. I don’t particularly want to be in a position of criticizing them. But with their record last year, I’m sure they are every bit as disappointed and surprised as I am. I would think, to them, indexing looks like a pretty darn good business.

Wiandt: What do you think the impact of all these leveraged ETFs and all the trading activity that you outlined is? Do you think that all that trading activity and the size of ETF trading—which some days is over 40% of trading in the market—is making for more volatile markets, is actually affecting what is going on in stock markets?

Bogle: Well, I struggle a little bit with that. I’m not sure enough of the data. For example, when we say that SPDR has 10,000% turnover, if you have a buy and a sell at the same time or almost at the same time of, say, 100,000 shares of the SPDR, that’s a volume number that is counted but doesn’t result in any stock changing hands. You are just offsetting the buyer against the seller. So I haven’t been able to cut through that fog. You know, the people that are running those businesses, I think, have some kind of an obligation to report exactly how much trading goes on. And, beyond my expertise, they may actually be doing that. I just don’t know that. It is certainly something we should know.

But in general, I looked at index fund trading, oh, a few years back before these ETFs got so big, maybe three or four years ago. And index fund trading counted for about 0.4% of all securities trading on the various companies—General Electric, Microsoft and companies like that. So 0.4% can’t be looked at as something that is driving the mare here. It’s got to be smaller. It is something that ought to be investigated. But the evidence I have so far is that you can’t really place the responsibility for market volatility on index funds. Although the growth of ETFs in the last few years may have changed that conclusion.

Wiandt: We have a couple of macroeconomic-focused questions. So I will ask those. The term “systematic risk” has become a scare tactic that the government uses to justify bailouts and defraud taxpayers. What is your view of systematic risk? What is your view of the bailout and how the government has reacted to the financial crisis?

Bogle: Well, I think it is a little over the top for me to say that the government is defrauding taxpayers. I don’t know quite the context to put that in. I would strike that from anything I could possibly respond to. I just don’t believe it is true. The more relevant question is, I suppose, that when we had this enormous risk to the financial sector of the economy, primarily—we will talk about that first.

The federal government had to do something. And I think what they have done is moving in the right direction, and that is, these banks were out of liquidity. They had created banks and investment banks together. And insurance companies we now know too were part of it, including AIG, American International Group, which was probably the worst of the bunch—doing all kinds of investment… engaging in all kinds of speculative activities that led to the market meltdown we had and where credit actually froze.

And all developed economies operate on free credit. When the credit markets close down, the government can’t just say, “Too bad.” Almost every small business, many individuals, we all depend on credit one way or the other for maybe just a short time, maybe a longer time. So the government had to take action. And I think they took the right action. I think they took the right action in approximately the right dimension.

Although it’s interesting that the actions they have taken have really … they said (a) and the actions turned out to be (b). So if we talk about the troubled asset repurchase program, so-called “TARP,” —I call it the toxic asset repurchase program—that was passed by the Congress under great, great pressure on October 15. It became a campaign issue, you may recall. And they still haven’t made their first purchase of a troubled asset all this time later. What they did, despite the obvious intent of Congress but maybe not the words, is funded the equity capital positions of banks rather than buying the troubled assets.

I’m not sure how easy it is going to be, even with this new public-private investment partnership—the PPIP—how easy it is going to be for us to do trading or have liquidity among these troubled assets. Because as I understand it, bank A is very reluctant to sell one of its toxic assets at, say, 25 cents on the dollar because they’ve got a whole portfolio of toxic assets. And they are scared to death they are going to have to mark them all to 25 cents.

My understanding of what’s going on in the financial economy out there is that 25 cents, give or take, may even be a little bit high. It is roughly what these toxic assets are going to prove to be worth, or at least most of them are going to prove to be worth. So it’s going to be very hard to get them paid off. It is going to take a lot of time. But, obviously, we eventually have to reverse this tremendous leveraging. We have to de-leverage our financial economy—to say nothing of our individuals who have heavy credit card debt, enormous mortgage debt. And there is a decent amount of corporate debt, although not nearly that excessive out there, too.

I mean, debt in our economy, I think, used to run around 60% of our gross domestic product. I believe it got up to around 135% or 140% of late. So we have to do the de-leveraging. The government had to play a role in maintaining liquidity in the system. So, while I can’t defend the exact way they did it—I don’t think anybody knows exactly how to do it—I would defend the policy that calls for government intervention.

Wiandt: We have a lot of questions about ETFs. There are a couple of lines of questions. One basic line is, are ETFs a good investment for a buy-and-hold investor? If someone buys an ETF and holds it for a long time, is it a good investment? Is it potentially a better investment than a traditional mutual fund structure?

Bogle: Well, the answer to that is yes. Unequivocally, it’s a better investment than a traditional mutual fund. Is it better than a classic mutual fund that is indexed? Or to put it another way, is the SPDR a better bet than the Vanguard 500 Index bought directly from Vanguard? That all depends, like everything else in this world—I don’t see that there is a particular, in the abstract, a particular advantage one way or the other. I don’t think the SPDR is necessarily better. Its cost might be a little bit lower than, say, a brokerage commission. The Vanguard 500 Index’s cost is a hair higher, but there is no commission.

I believe, by the way, that the tax efficiency of the SPDR, to the extent that it exists, is going to be indifferent from the standard S&P 500 Index Fund of Vanguard. We have been able to manage that fund with almost no realized gains. Particularly with the market of recent years, we’ve had plenty of high cost of stock in that index fund. Now, when you start to fine-tune it a little bit for an investor accumulating money, it’s absurd to buy the exchange-traded fund because you have to pay a commission every time you buy it—when you reinvest dividends, all those kinds of things—where that is done automatically for you at a known asset value in the 500 index fund.

So for the periodic investor or the retirement plan investor, it would seem to me, just on the mathematics involved, and assuming the performance of the two is the same … I’ll come back to that in a moment … but you don’t have to worry about tax efficiency for retirement plans. I’d say the 500 index is clearly―just because of the math―the superior choice. So you can flip a coin one way or the other.

But in general, long-term investing in the right kinds of index funds, by which I mean, broad market index funds—whether it is S&P 500, total U.S. stock market, possibly the emerging markets, certainly the developed international markets, the total international as we call it—I think they are pretty even competitors. And that is a perfectly good way to invest, and you almost certainly over time substantially outpace, no matter which way you go―ETF or standard index fund―the results of actively managed funds in the same area.

Did I cover all of that, Jim?

Wiandt: I think you did a pretty good job on that one. A follow-up question is, all this trading activity that you outlined for ETFs―does that damage the long-term buy-and-hold investor who is in ETFs?

Bogle: Well, the ETF returns―a little bit surprisingly to me―come pretty close to their category returns. It doesn’t seem to be damaging. And that said, if you are, in fact, are a long-term investor, it should matter very little. Because they seem to be able to produce the return of the index, or emulate it. For the short-term investor, there are often serious variations between the net asset value of the ETF and the market price at which it is trading, particularly in the less liquid market. So you are just flipping one more coin when you get into that game and, therefore, I wouldn’t recommend it.

Wiandt: Another question on ETFs: What are the safeguards and diligence that should be taken by an investor who is looking at ETFs? What sorts of ETFs should we be looking at, and what are the issues about structure or index that we should be looking at?

Bogle: Well, I’m someone who believes in simplicity rather than complexity. And buying the index funds in any of these broad categories is, by far, the simplest way to do it. You don’t have to worry about capital gains. And there are an awful lot of funny things going on in some of the wild ETFs and a great deal of tax inefficiency and large capital gains, things like that, that don’t seem to apply to the bigger indexes, like the bigger index funds, the bigger ETF funds.

But I just go the simple route, because it is clear and nothing can get in your way. You are not in business with all these speculators. And if that starts to make a difference, you won’t be influenced by it. So I would go to the standard index fund just on the basis of simplicity. If you’ve got a tenth of a point return less—and I can’t imagine it can be much different from that, 0.01% per year—I would say that is probably a price worth paying not to have the risk.

There are also quite a few variations on this. Some of these ETFs—I don’t want to speak too strongly about it, but they verge—their concepts verge on insanity: triple leverage, up markets, down markets, new ways to beat the market—how about exchange-traded notes, which are ETFs [or ETNs]? That is basically a call or a promise to pay you the index return by an outside financial organization. And some of them have gone bankrupt, so the exchange-traded notes became worthless. You just be very careful that you are not into the note business. You can’t be sure, ever, what will happen.

So I would say, opt for simplicity. Remember Ockham’s razor. Our friend, Sir William of Ockham, says, “You know, if there are multiple solutions to a problem, choose the simplest one.”

Wiandt: It looks like we have got an active investor here with a question. I think you may enjoy this one. He says, “Jack, you continue to encourage individual investors to buy and hold. However, I challenge you to name one goal-oriented endeavor besides investing where an intelligent individual would select a passive approach over an active one. Can you name even one?” he says.

Bogle: I’m sorry. You are just going to have to explain the question. Name even one investor?

Wiandt: Some activity that you would want to do in life where you would choose to be passive instead of active as a way of succeeding.

Bogle: Oh, that is such a great question! And, you know, there is an answer to it. And this is why we get so messed up in the financial business. Would you go to an average doctor? No. Why would anyone go to an active doctor, to a passive doctor or not the best doctor around? The problem is, in the financial markets, they are different from any other endeavor in American life. And that is, there is a market out there and it has a certain value. And all of us together own that market.

So literally the only way to capture the market return is to own the market without cost. That cannot be done. But you can do it with a cost of as little as 0.1%, and you will, by definition, beat all these other investors who do it at a cost of maybe 2%–2.5%. There is really not any mystery about this. It is all what I’ve been willing to call or have been able to call the “relentless rules of humble arithmetic.” Get the croupiers’ take out and you capture the market return; you as a group of investors. Lave the croupiers’ take in—pay the croupier … pay Wall Street … pay the money managers … pay the brokers … pay the investment bankers … pay the investment advisers … and you get what’s left.

You know, you are sitting---you individual investor who has asked the question—you, pal, are sitting at the bottom of the food chain of investing. You know, everybody gets paid before you do. Where else is that true in American business? I don't know if it is true anywhere else at all. So, yes, unequivocally, it is different and it has to be different. And our failure to acknowledge that difference is what gets us into so much behavioral problem.

Wiandt: Is there a role for financial advisers in helping individual investors? And if there is, what is a reasonable sort of cost for a financial adviser?

Bogle: Well, I happen to believe the financial adviser serves a very useful purpose for many, certainly not all, but for many, and perhaps even most, investors. We put the stock market and the bond market and financial planning in this aura of great mystery. And if you have been around long enough, and I think I have been around long enough, although I have to be around a little bit longer—if you have been around long enough, you realize that there is not that much mystery about it. The idea is to capture the returns of the bond market and the stock market, essentially.

And that is all there is to it: to capitalize on the miracle of compounding returns and avoid the penalty of the tyranny of compounding costs. Because in the long run, the tyranny of compounding costs overwhelms the magic of compounding returns. If investors understand that much and are broadly diversified, they can really operate on their own. Now, not everybody can do that. There are motions that they don’t understand the system to begin with. They probably think they are a lot smarter than the system. They barely know a stock from a bond and don’t know what managers to trust and what managers not to trust.

So I think the investment adviser can play a very useful role, particularly in fund selection and in asset allocation and, in general, trying to help investors avoid the penalties of the behavioral kind of investing; of doing dumb things at dumb times. We may even need a financial adviser to, at times of crisis, have the courage to say to his clients or her clients, “Don’t do something. Just stand there. Stay the course.” It is generally better than moving your money around at times of crisis.

What is a fair price to pay for that? Obviously, it varies greatly. By the way, I should say much more than parenthetically, I don’t think we should rely on financial advisers to pick the best funds for us. They can pick intelligent funds. They can pick broadly diversified funds. They can pick funds with low turnover and funds with low cost. But picking funds that win is pretty much hazardous duty that nobody, now matter what their knowledge is, has really the ability to do. We rely too much on fast returns.

I think the idea is to have the adviser help you capture as much of the market returns as you can do. What’s a fair price to pay for that? Well, we talked. And in this funny, funny industry which I’m part of, we always talk about percentage turnover. I think we ought to be thinking more about dollars. And 1% is certainly not an excessive fee in terms of revenues it generates for an adviser who has got to be interested in taking care of you.

If you have $10,000 or $50,000 or $100,000 to invest, I would argue 1% might even be too low. But if you take any more of that, it is too big a hit out of your long-term compounded return. But once you get to a larger investment, I think that 1% should be scaled down somewhat—so the adviser is treated reasonably well, but not a flat percentage all the way up in the millions of dollars. I happen to believe that is just too much money for too many assets.

So the adviser has to be worthy of his hire. And then you’ve got to figure out what that worth is. And something in the range of 1% scaled down as the account grows is a reasonable place to start. I don’t think it is easy to go beyond that except to say that at some point, I would think, maybe advisers will start to work on a fee basis, like a lawyer might work, like a doctor might work, something like that. The amount of attention he gives you—the investor—is what you are paying for: his time and effort rather than an asset-based fee. That may come to develop over time.

Wiandt: An asset allocation question: One of the main reasons we use asset allocation and diversification in our portfolio is to balance the risk. So if one thing is going up, another thing is coming down. If one thing is coming down, you’ve got something else coming up. The problem is—and if you look to October you can see this—when things go bad, it seems like everything goes down. And so what can you say to that? Is there anything that people should do in that environment or do you just ride it out?

Bogle: To me, first, in general, the question is correct insofar as it applies to equities. And it’s been long said—many, many years ago, and it’s proved so true in every crisis since then—international diversification lets us down just when we need it the most. And truer words than that were never spoken. On the other hand, the fact is that bonds produce a very good countercyclical return.

I don't know exactly what they did in September. But I mentioned at the beginning of my remarks that the bond index fund went up 5% last year. That really was counter in direction, if not in amount, to the 35%, 37% decline in the U.S. stock market. Now I look at bonds as being the ultimate diversifier. I don’t look at diversification in equities [in terms of] being in different equity styles as being particularly helpful in the long run.

Look, we all know there are times when growth is doing better than value and vice versa, that large-cap is doing better than small-cap and vice versa. But they seem to come back. They seem to revert to the mean over long, long periods of time. And it’s very hard. Individual stocks, individual styles, have a very similar correlation with a stock market as a whole, a very similar correlation with one another and with the stock market as a whole—even down to the individual stock level and the style level and the manager level. So I think if you are looking for safety, the best instrument for safety is a high-grade bond portfolio, including Treasuries and high-grade corporates.

Wiandt: What are Jack’s thoughts on using inverse ETFs for short-term tactical hedges for those individuals who can’t stomach some of the rides for true long-run buy-and-hold theory? In other words, what role do these products have, if any?

Bogle: None. Did I make my position clear? No, the problem is, it is wonderful to buy a leveraged short ETF just before the market goes way down. I think to put the question in that way is to answer it. Who knows when the market is going to go way down? The time you are most likely to buy that kind of a fund is when the market has gone down. It’s a kind of inverse performance-chasing. I don’t like tricks. They require timing. They require more courage than I have. And they require a belief that you know more than the market.

In my very first book, one of my rules at the end, my principles, my 12 pillars of wisdom, was, “Never think you know more than the market. Nobody does.” Investing is putting money to work where it earns an internal rate of return: interest rates, dividend yields, earnings growth. It is not guessing what prices are going to do next. You know, we all ought to know by now that the stock market is the way we buy the returns of American business over time, the way we participate in the returns of American business over time.

But it also turns out that on any short-term basis, the stock market is a giant distraction to the business of investment. Of course it is. An inverse ETF is a bet on the market taking a certain direction and a bet that you are smart enough to do it, so you better double your bet on the way down. I don’t mean to be too tough on these kinds of funds, but I think anyone that does that is crazy. But I wish them well. I always wish them well.

Wiandt: Here is a bit of a technical question. Professor Jeremy Siegel has challenged the method of calculating the S&P 500. He believes that the calculation should be earnings-weighted as opposed to cap-weighted, capitalization-weighted by market weight. What are your thoughts on that?

Bogle: It just isn’t true. Can I make it clearer? The fact of the matter is, this issue arose earlier in the year. And by the way, the Wall Street Journal had a very powerful and accurate response from Standard & Poor’s as to why it was statistically unsound. It is just not a good statistical technique.

[The S&P response took the example of] one little company that had a great big dollar amount of earnings loss. And to think about it this way, supposing that little company, just before it announced the loss, had been bought by, let’s say, Exxon; the company was bought by Exxon. The loss would be exactly the same. It would be carried over to their balance sheet but it would be in a big company.

The index is already weighted by market cap. It is clearly weighted by dividends; each company’s dividends and each company’s aggregate earnings. When there is an aberration, you just have to live with it. Call it an aberration. Call it anything you want but don’t change the weightings of earnings because it just doesn’t make statistical sense. I’ll bet Jeremy Siegel has had second thoughts about his position, by the way.

Wiandt: Jack, are you planning to write another book, perhaps an opus of your life?

Bogle: Well, that’s a good question. I think when my life’s work is done I’m going to write the book, but I don't know when that will be. But I’m not planning it right now. As the last paragraph in “Enough” says, “One must wait until the evening to enjoy the splendor of the day.”

Wiandt: Where do you see dividend yields going forward? Conventional experts see much lower returns. What are your thoughts on this? What are your thoughts on forward market returns?

Bogle: Well, my theory, or my mathematical construct—which I’ve been using for a long, long, long time now, certainly decades—is that in the long run, market returns are 100% composed of what I call investment returns, dividend yields at time of entry into the market and the earnings growth that follows. That’s not a very complicated way to look at it. But it turns out that it is totally accurate when you look at the returns of the market over the long run.

You have this element of what I call speculative returns, which is changes in valuation. If the price earnings multiple of stocks goes from 10 times earnings to 20 times earnings, that doubling over 10 years adds 7% a year to the returns on stocks. And we actually had that. That happened twice, in the ’80s and again in the ’90s.

But it can’t happen forever. In the long run, 100% of market returns or investment returns and speculative returns come and go. But in the long run they amount to nothing. So investment returns in the future will probably drive the market. I don’t look for speculative returns to drive it up or down a great deal, certainly not by 7% a year.

Right now the dividend yield looks to me to be about 3.25%. I had it at 4% earlier this year but we had a big drop in dividends, one of the biggest cuts in dividends—around a 22% drop is forecast for the S&P 500, and I don’t see that drop is going to be repeated in the kind of economy I see. I think most of the drop is behind us. So using the current dividend yield, down 20% from last year’s, would give us around a 3.25% yield.

From this level—well, let me first say, when one spends just a moment of time on the simplicity of it, we know a lot about earnings growth. And that’s the other component of the investment return. We know that from the beginning of time, practically, corporate earnings grow at the same rate of our economy over the long term. And so if our GDP has been growing at 5%, then corporate earnings should be growing at 5% nominally. and they do.

And what is interesting about that is that they are in a very narrow channel. If you are looking at them a little bit differently, corporate earning generally account, after taxes, for 4%–8% of our gross domestic product. That is a very narrow channel and they average about 6% of GDP. So let’s assume from these depressed earnings levels, that instead of growing at 5% as the economy may grow—it may grow a little slower than that—the corporate earnings can grow at 6% or 7% from here. It is conceivable.

It’s a probability, I think, but certainly not a certainty. So if you are going to use 6%, that is a 9.25% return on stocks. Let’s assume that maybe that valuation comes down and takes a point of that return. You ought to be looking at 8%, perhaps 7% return on stocks, which is pretty good, if not very good. Because when we do the same mathematics for the bond market at today’s interest rate on a portfolio of governments and corporates roughly equally weighted at today’s interest rates—it is going to be 4.75% or 5%. So let’s call it 5% for simplicity.

If you compound over the next decade at 8% instead of 5%, you ought to be a pretty happy investor. So I’m optimistic, although I want to underscore that in these economic conditions, one has to look at not only the possibilities of what the future returns will be in the rough dimensions that I described here—but the consequences to you if they are not. And if you are too exposed to equities and things go wrong—and they can always go wrong—the stock market is a bad place for hope. You want to be conservative, even though the odds favor the stocks doing significantly better than bonds in the coming decade.

Wiandt: We have time for a couple more questions. The federal government has made a massive infusion of money into the market. What does this portend to the value of the U.S. dollar going forward, and is there anything that investors should be doing about that to protect themselves?

Bogle: Well, it should portend a rapid drop in the dollar. But the dollar is, of course, affected not only by the financial side but by the expectations of investors. So I’m not sure it’s a lead-pipe cinch that the dollar will be hugely weak. It came out about $1.17 relative to the euro all those years ago and it’s not all that far from it now. I don't know the current rate. Say maybe $1.40. I haven’t looked recently. That is not a huge change for a decade against the euro.

So predicting the dollar is like any other prediction. You can be right and you can be wrong. And if the dollar is, in fact, weak, I think everybody understands that will be great for international U.S. corporations. So it should help equity prices. I don’t think one should base an investment strategy on the fact that one thinks one knows what the dollar is going to do in the years ahead. Although I would be inclined to agree with the thrust of the question and that is, it’s hard to think that we can have a stronger dollar over the next four or five years.

Wiandt: This is another asset allocation-focused question: Given the almost unprecedented experience of 10 years with bond and equity prices—where you saw bonds really outperform equities over a very long time horizon—should investors be looking at how they do asset allocation between fixed income and equities in a different way?

Bogle: Well, it’s funny that after the previous 20 years ended in 1999 with bonds doing so much worse than stocks—although if you start at the beginning with very high interest rate yields, bonds did actually pretty well—the average return on bonds running through those years was probably about 6% or 7%. And the return on stocks was about 17% over 20 years. And everybody was saying, “Shouldn’t we have more stocks?”

And the answer is “No. You shouldn’t have more stocks.” They are selling at very high valuations and there is a lot of reversion to the mean. You know, high stock returns tend to be followed by low stock returns. Great booms are followed by great busts. Prices revert to kind-of normal valuations over time. So at this time, I don’t think that one should pay a lot of attention to what happened in the last 10 years. I think what happened in the last 10 years—particularly to the stock market, or entirely to the stock market---is very much a reversion of the mean of the excess, greatly excess return that we had in the two previous decades.

Don’t forget, as 1999 ended and 2000 began, stocks were selling at almost 40 times earnings. That can’t stay at 40 times earnings; it has to come down. Now, in this muddy situation that we have, they are probably selling about 20 times these depressed earnings. It’s hard to get a handle on that. But half as highly valued and could come down a little bit. But bond returns … people should understand very importantly about bond returns that today’s yields are the best possible approximation of what bonds will deliver in the next 10 years. Let’s call that a 5% return.

There happens to be, over time, a 91% correlation between the interest rate in which you go into the bond market at and the return that the bond market provides over the next 10 years. So we have a pretty good idea that bond returns would be about 4%–6%. You take your chances on stock returns, and if you think they are going to be much lower than that guess I gave—I suppose if you are a market timer, you should reallocate to bonds if you think stocks are going to return less than 5%. But I don’t think we know enough to do that with much confidence.

I would further say, to me, now—and I’m very conservator investor, extraordinarily conservative—that I believe your bond position should equal your age. And my bond position does equal my age. So I really had a good year last year. Sometimes it’s a blessing to be old, but only rarely.

So, I think one should look at one’s asset allocation in a certain way. Let’s say you decide, for a whole bunch of reasons, that you want to be, say 70%—you’re a younger investor—70% in stocks and 30% in bonds. If you think you can do some forecasting about the direction of the bond or stock market, particularly the stock market, and you think it is going to be down, don’t get out of stocks at 70%, maybe go to 60%. Don’t go below 50%—call it 20 percentage points below your allocation—any more than you should never go above that.

I don’t think that is a good strategy. But it is a much better strategy than thinking, “I’m either in the market or I’m out of it.” Those wholesale changes in equity ratio I think are going to destroy the retirement funds of countless investors that follow it.

Wiandt: We are moving toward wrapping up now. I just have a couple of things to note. We have all the slides up and a recording of the webinar up on the Web site, IndexUniverse.com.

With that, I just really want to thank you, Mr. Bogle, for taking the time with all the investors here. I think it was outstanding. And I’m sure that all the Bogleheads out there really enjoyed it. And thanks to all of you for attending as well.

Bogle: Well, I enjoyed being with all of you. I hope you will forgive my bluntness, but any of you who know me realize it is probably a little late to give up on that. Have a great day everybody.

Chicago, IL - June 18, 2009 - Zacks.com releases the latest Zacks Industry Rank. Stocks featured in this week's analysis include Invesco Ltd. (IVZ), Franklin Templeton Investments (BEN), AllianceBernstein Holding (AB), BlackRock (BLK), Barclays (BCS), T. Rowe Price Group (TROW) and Janus Capital Group (JNS).

Zacks Industry Rank Analysis is written by Charles Rotblut, CFA, Senior Market Analyst for Zacks.com.

This Week: Forecasts Rising For Fund Managers

The spring rally has led to higher profit expectations for mutual fund managers.

To a large extent, this is a bit of a no-brainer for those who understand how the investment management industry works. Money managers earn a fee based on assets under manager (AUM). Any increase in the size of a portfolio should result in more fee dollars.

The S&P 500 rose approximately 40% since early March. All things being equal, AUM should have increased as a result.

However, fund managers have also enjoyed an influx of dollars. According to Strategic Insight, U.S. investors added more than $55 billion into stock and bond funds last month, making May the second consectuive month with $50+ billion of inflows.

It's worth adding the calendar into the explanation for why estimates are rising. The first-half of the year is almost completed. We already know what the first-quarter profits were and the data signals that the second-quarter should be strong. This means that analysts should have greater confidence about what full-year earnings will look like than they did 2 months ago.

But, given that most of this is already known, why did many analysts wait until the past 7 days to raise their forecasts? The announcement of May AUM numbers are the likely reason.

Last week, Invesco Ltd. (IVZ), Franklin Templeton Investments (BEN) and AllianceBernstein Holding (AB) all said AUM rose in May relative to April. Though this should not be surprising, analysts probably wanted confirmation of higher AUM before adjusting their profit forecasts.

Earnings Estimate Revisions
Company	Stock	2009 EPS Forecast	1-Week Change in Forecast	Number of Revisions
AllianceBernstein Holding	(AB)	$1.10	7.8%	4
Franklin Templeton Investments	(BEN)	$2.71	3.4%	8
Invesco Ltd.*	(IVZ)	$0.63	1.6%	8
Janus Capital Group	(JNS)	$0.30	15.4%	3
T. Rowe Price Group	(TROW)	$1.29	3.9%	5

*Profit projections for IVZ are up a total of 5% since late May.

Mergers Could Provide An Additional Boost

Though the trend in earnings estimates revisions is a positive, there is also speculation that more mergers could be forthcoming in the industry.

Such discussion was brought to the forefront last week with BlackRock's (BLK) acquisition of Barclays Global Investor. Once the deal is completed, it would make BLK the largest money-management firm. Included in the deal is Barclays' (BCS) iShares business.

Still, it's important to realize that mergers are unpredictable. Therefore, investors should view the potential for other deals as a possible bonus, rather than a reason to invest.

Still Room For More Upward Revisions

A better strategy than counting on a merger would be to keep an eye on the Zacks Rank. T. Rowe Price Group (TROW) is a Zacks #2 Rank ("buy") stock. AllianceBernstein Holding (AB), Franklin Templeton Investments (BEN), Invesco Ltd. (IVZ) and Janus Capital Group (JNS) are Zacks #3 Rank ("hold") stocks.

The sheer number of covering analysts is reason why none of the stocks are on the Zacks #1 Rank ("strong buy") list. Agreement is one of the factors considered by the Zacks Rank and while several analysts have raised full-year forecasts, others have not. The lack of revisions by all of the covering analysts hurts the Zacks Rank, but also provides the potential for more estimate revisions.

The assumption being, of course, that current consensus estimates are too conservative. Given current trends, this assumption may well turn out to be correct.

(BLK and BCS are also Zacks #3 Rank stocks. However, the short-term outlook for these companies could be impacted more by the pending merger than earnings estimate revisions.)

Zacks "Profit from the Pros" e-mail newsletter offers continuous coverage of the industries and the stocks poised to outperform the market. Subscribe to this free newsletter today by visiting http://at.zacks.com/?id=5611.

About Zacks

Zacks.com is a property of Zacks Investment Research, Inc., which was formed in 1978 by Leonard Zacks. As a PhD in mathematics Len knew he could find patterns in stock market data that would lead to superior investment results. Amongst his many accomplishments was the formation of his proprietary stock picking system; the Zacks Rank, which continues to outperform the market by nearly a 3:1 margin. The best way to unlock the profitable stock recommendations and market insights of Zacks Investment Research is through our free daily email newsletter; Profit from the Pros. In short, it's your steady flow of Profitable ideas GUARANTEED to be worth your time! Register for your free subscription to Profit From the Pros by going to http://at.zacks.com/?id=5610.

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Disclaimer: Past performance does not guarantee future results. Investors should always research companies and securities before making any investments. Nothing herein should be construed as an offer or solicitation to buy or sell any security.

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To a large extent, this is a bit of a no-brainer for those who understand how the investment management industry works. Money managers earn a fee based on assets under manager (AUM). Any increase in the size of a portfolio should result in more fee dollars.

The S&P 500 rose approximately 40% since early March. All things being equal, AUM should have increased as a result.

However, fund managers have also enjoyed an influx of dollars. According to Strategic Insight, U.S. investors added more than $55 billion into stock and bond funds last month, making May the second consectuive month with $50+ billion of inflows.

It's worth adding the calendar into the explanation for why estimates are rising. The first-half of the year is almost completed. We already know what the first-quarter profits were and the data signals that the second-quarter should be strong. This means that analysts should have greater confidence about what full-year earnings will look like than they did 2 months ago.

But, given that most of this is already known, why did many analysts wait until the past 7 days to raise their forecasts? The announcement of May AUM numbers are the likely reason.

Last week, Invesco Ltd. (IVZ), Franklin Templeton Investments (BEN) and AllianceBernstein Holding (AB) all said AUM rose in May relative to April. Though this should not be surprising, analysts probably wanted confirmation of higher AUM before adjusting their profit forecasts.

Earnings Estimate Revisions
Company	Stock	2009 EPS Forecast	1-Week Change in Forecast		Number of Revisions
AllianceBernstein Holding	(AB)	$1.10	7.8%		4
Franklin Templeton Investments	(BEN)	$2.71	3.4%		8
Invesco Ltd.*	(IVZ)	$0.63	1.6%		8
Janus Capital Group	(JNS)	$0.30	15.4%		3
T. Rowe Price Group	(TROW)	$1.29	3.9%		5

*Profit projections for IVZ are up a total of 5% since late May.

Mergers Could Provide An Additional Boost

Though the trend in earnings estimates revisions is a positive, there is also speculation that more mergers could be forthcoming in the industry.

Such discussion was brought to the forefront last week with BlackRock's (BLK) acquisition of Barclays Global Investor. Once the deal is completed, it would make BLK the largest money-management firm. Included in the deal is Barclays' (BCS) iShares business.

Still, it's important to realize that mergers are unpredictable. Therefore, investors should view the potential for other deals as a possible bonus, rather than a reason to invest.

Still Room For More Upward Revisions

A better strategy than counting on a merger would be to keep an eye on the Zacks Rank. TROW is a Zacks #2 Rank ("buy") stock. AB, BEN, IVZ and JNS are Zacks #3 Rank ("hold") stocks.

The sheer number of covering analysts is reason why none of the stocks are on the Zacks #1 Rank ("strong buy") list. Agreement is one of the factors considered by the Zacks Rank and while several analysts have raised full-year forecasts, others have not. The lack of revisions by all of the covering analysts hurts the Zacks Rank, but also provides the potential for more estimate revisions.

The assumption being, of course, that current consensus estimates are too conservative. Given current trends, this assumption may well turn out to be correct.

(BLK and BCS are also Zacks #3 Rank stocks. However, the short-term outlook for these companies could be impacted more by the pending merger than earnings estimate revisions.)

Zacks Premium and Zacks Elite subscribers can view the Zacks Industry Rank List at http://www.zacks.com/zrank/zrank_inds.php. This interactive list allows you to see all of the companies, and their Zacks Rank, within more than 200 industries. Shown below is the Zacks Sector Rank List, which shows the trend in estimate revisions on a broader scale.

Sector Rank as of Jun 17
Sector	This Week's Zacks Rank	Last Week's Zacks Rank	FY09 Revisions Ratio	FY09 Estimates Revised Up	FY09 Estimates Revised Down
Retail-Wholesale	2.52	2.51	3.42	629	184
Consumer Staples	2.80	2.83	2.08	181	87
Consumer Discretionary	2.85	2.87	0.84	123	147
Medical	2.91	2.89	1.02	244	240
Computer and Technology	2.94	2.93	2.01	570	284
Conglomerates	2.96	2.89	1.50	9	6
Utilities	2.97	2.99	0.72	75	104
Business Services	3.01	2.96	0.95	36	38
Oils-Energy	3.02	3.06	0.85	325	381
Auto-Tires-Trucks	3.06	3.09	0.76	28	37
Basic Materials	3.10	3.10	0.75	130	173
Aerospace	3.13	3.20	0.48	14	29
Finance	3.17	3.17	0.87	474	544
Construction	3.18	3.13	0.56	42	75
Industrial Products	3.18	3.16	0.69	93	134
Transportation	3.25	3.27	0.36	69	192

Charles Rotblut, CFA, is the senior market analyst for Zacks.com. He can be reached at crotblut@zacks.com.

Zacks Investment Research

ETF and index people the world ‘round are smiling today. $13.5 billion is a big number. And this BlackRock deal is big not just for the index/ETF industry, but the financial sector in general.  It underscores just how big basis point-linked passive assets have gotten.

As I said a couple days ago in my IU.eu blog titled BlackRock IS the Buyer (Paul Amery has a nice follow-on blog there as well), this is a powerhouse deal. It’s a deal that minces no words, and says what it means. And what it means is we’ve suddenly got a global behemoth, THE global behemoth of an asset manager, with $2.7 trillion in assets. Good lord.  And frankly, on paper at least, it’s a marriage made in heaven, with BGI in a dominant position where BlackRock is mostly absent: ETFs and institutional indexed asset management.

So, wow.

There are a lot of questions that come to mind.  Here are a few of them, which I’ll leave you to ponder:

• How did this deal go from $4.2 billion to $13.5 billion? The short answer is that it included not just iShares (it now makes that piddly $175 million buyout of the CVC Capital Partners deal seem like an afterthought).  Still, the reported bids for the entire BGI entity were still just $6 billion plus.  We’ll dig around some more (more than double is a BIG difference), but there was either misreporting, or this is apples to oranges. The other deals that were announced were highly leveraged. That is certainly one factor.
• Did this deal just come up from out of the blue? No. Other comments of note are that, according to the New York Times article posted this morning, the merger/takeover has been in certain people’s minds for 6 years.  Also of interest is that much of the funding came from Middle Eastern investors – an interesting angle (you can see why in Paul’s earlier reporting on the transaction).

Here are some other big questions I DON’T have the answers to (thanks to Matt Hougan, whom I’d discussed this with yesterday, as Dagen McDowell was cuing up a Fox Business News interview with BlackRock CEO Larry Fink and had asked for our thoughts):

• Will BlackRock commit to keeping the iShares expense ratios at or below their current levels?
• How will this deal affect the launch (or not) of actively-managed ETFs? iShares was certainly looking at it. Does this deal accelerate that process or put it to a grinding halt?
• Will there be significant layoffs as the two operations combine and find economies of scale?
• How much autonomy will existing iShares and BGI people have in the new organization?
• Will the added scale of a combined BGI and BlackRock allow them to lower the cost of quality management? (presumably the answer is yes, the question is how much of that efficiency will be transferred to investors and how much to the BlackRock bottom line).
• Where does BlackRock consider the future of asset management to be? ... with active funds, a passive core with active satellites, or passive funds applied actively?
• Does BlackRock feel like they are getting a deal ... Finding a gem amid the financial crisis wreckage?
• What is more intriguing to BlackRock - BGI or iShares?
• Given BlackRock's (very) active tilt, how strongly do they believe in passive management? After all, they suddently become the largest index player in the world.  Do they believe in the business or do they just want the share lending revenue?
• How active a role will Barclays (now approximately a 20% stakeholder in the new combined entity) play in shaping what BlackRock does?  Remember, also, that Bank of America (through Merrill Lynch) has a significant stake in the merged group (35%, according to today’s Financial Times).

There is no shortage of interesting questions to look at.

In perhaps one of the worst-kept secrets in exchange-traded funds industry history, giant asset manager BlackRock Inc. said late Thursday it had finalized a $13.5 billion deal to buy Barclays Global Investors.

The combined company, to be called BlackRock Global Investors, will represent nearly $3 trillion in assets under management.

Interestingly, Barclays will keep about a 20% stake in the new BGI. BlackRock will only have to fork over about half of the estimated deal amount in cash; according to reports, BlackRock is exchanging shares of its common stock to complete roughly the other half of the mega-merger.

Officially, Barclays' original buyer (CVC Capital Partners ) has about a week to try to match BlackRock's offer. But the private equity firm would face a big upgrade in terms. CVC Capital  almost had a deal for all of BGI in early April. The price tag at the time was listed at $4.4 billion. But it also came with plenty of strings, including parent Barclays providing much of the financing and an escape clause for the seller if a better bid could be found by June 18. (See related story here.)

And that's just what happened. Nearly two weeks ago, reports started circulating that BlackRock had put together a package that made a deal trumping CVC Capital's highly likely. The stories even detailed Barclays maintaining a 20% stake in the new BGI and many other financing terms. (See related story here.)

Then, last week, reports emerged that pretty much stated Barclays had settled on BlackRock. (See related story here.)

What will be the combined impact on the growing ETF market? Analysts immediately afterwards are looking at the world's largest insitutional money management firm and beefed-up ETF provider as dominant in both marketplaces -- especially ETFs.

But others aren't so sure that such a merger will pay huge dividends, at least right away. Some industry veterans point to a shaky history for mega-mergers between asset managers and diversified financial services firms. (Going against that trend, of course, is the fact that BlackRock by most accounts has successfully integrated the former Merrill Lynch money management arm.)

Then again, a revamped BGI faces a number of internal changes cutting at the core of the ETF marketplace. Consolidation has been taking place in both funds as well as asset managers. And many industry veterans are seeing less differences between the types of customers providers service in coming years. (See related column here.)

Still to be resolved as well -- a $175 million buyout clause that CVC is reportedly owed for breaking its original agreement.

In any event, the deal isn't expected to close, barring any unforseen regulatory hurdles such a merger might raise, until late this year.

A little more than a month since coming out with the first traditional actively managed exchange-traded fund, Grail Advisors is making plans to launch four more.

In a filing dated June 8, the San Francisco-based asset manager says that it wants to complement the Grail American Beacon Large Cap Value ETF (NYSE Arca: GVT). That fund opened on May 4 and differs from others either currently on the market or in registration in that it implements a purely qualitative stock selection process. (See related article here.)

Each in the new group will do much the same. They'll be listed on the NYSE Arca exchange and charge expense ratios of 0.89% apiece. The proposed new ETFs are the:

• RP Growth ETF. According to the prospectus, RP uses a “fundamental research driven approach to identifying those industries and companies with the strongest growth prospects for revenue, earnings and/or cash flow over the medium- and long-term and seeks to buy stock in those companies at attractive valuations.”

Also, the ETF’s manager may invest in companies of any market capitalization and in any industry. The ETF expects to invest primarily in U.S. stocks, but it may also invest overseas.

• RP Focused Large Cap Growth ETF. This will use Wedgewood’s qualitative and quantitative analytical processes to pick 20-30 companies with $5 billion or more in market cap size. The manager will look for above-average growth prospects, and while focusing on domestic names, can also wander outside U.S. borders. According to the prospectus, “Wedgewood seeks investments in market leaders with dominant products or services that are irreplaceable or lack substitutes in today’s economy. Wedgewood invests for the long term, and expects to hold securities, in many cases, for more than five years.”

It adds that Wedgewood’s investment process “involves rigorous qualitative and quantitative inputs as well as a strict valuation and risk discipline.”

• RP Financials ETF. The subadviser plans to use fundamental research to pick financial services companies at attractive valuations. The ETF will primarily invest in companies with mid-to-large market capitalizations of between $2 billion and $150 billion. It will focus on U.S. markets but can also venture overseas.

• RP Technology ETF. Much the same in terms of looking for mid- and large-cap names, this ETF can also wander outside the U.S. It will focus on fundamental analysis and picking stocks with attractive valuations across almost every major sector of technology.

Unlike GVT, the new active ETFs will have a single subadviser. That will be RiverPark Advisors. One of the new ETFs, the RP Focused Large Cap Growth ETF, will have a secondary subadviser as well—Wedgewood Partners Inc.

But in an interview on Tuesday, Grail Chief Executive Bill Thomas said that RiverPark will serve as the primary adviser on that fund and handle running the portfolio.

RiverPark Advisors was founded by Morty Schaja, the former president of Ron Baron’s asset management firm. He opened RiverPark in 2006 with a long-short equity hedge fund. That has since closed and the firm is now specializing in long-only private accounts and ETFs.

“We believe the mutual fund model, which is almost 100 years old, is an outdated structure. In this 24/7 world, we’re very excited to be involved in ETFs,” said Schaja, from his New York City offices on Tuesday.

Grail's Thomas added that going with a single-adviser strategy is "the next step in the evolution of the ETF space.”

“Now, financial advisers and individual investors will have a broad choice of both team-managed and single-manager actively managed ETFs to choose from,” said Thomas.

He says that this will be the first in a series of ETFs Grail plans to offer with RiverPark, which is based in New York City.

In January, Grail filed to launch GVT. But it also included an international-focused ETF using the same sort of fundamental analysis and active management as the original. No word when that will appear, however. (See related story here.)

Vanguard has also filed to come out with an ETF that would mimic its actively managed mutual fund, the High Yield Corporate Bond Fund (VWEHX). And last month, Barclays Global Investors filed to launch its own set of actively managed ETFs. (See related story here.)

PowerShares was the first to bring active management to equity ETFs. But its family of funds relies largely on quantitative methodologies. Grail’s GVT opened the ETF universe to more traditional actively management, using bottom-up fundamental analysis that has been the domain of mutual funds in the past.

“Even though these are primarily managed by a single adviser, these are all continuing what we stated with GVT in bringing to the ETF market classic actively managed portfolios,” said Thomas. “Active management is the next wave and logical extension of the ETF marketplace. It’s going to be as big as index funds have been to ETFs up to this point.”

The filing for Grail's new ETFs can be found here.

-- This report was submitted by IndexUniverse.com's Murray Coleman.

New reports put BlackRock's deal for BGI at $13 billion.

During the weekend, several new articles appeared in British papers reporting that BlackRock Inc. is closing in on a deal to acquire Barclays Global Investors, the parent company of iShares, in a transaction worth up to US$13 billion.

But not all the reports were as definitive as the one coming out of the US late last week. Pensions & Investments magazine, on its Web site, broke the news late Friday afternoon after markets had closed in the US. It quoted unnamed sources as saying that the groundwork for a deal was in place and that an announcement would be forthcoming.

The story also had estimates that a BlackRock purchase of BGI would surpass $10 billion. (See related story here.)

However, in a story over the weekend, a report out of London by the Financial Times said that Barclays isn't expected to reach a decision until early this week on who will purchase its asset management division.

Also, more details are leaking out about the complexity of such a transaction.

Barclays is expected to acquire a stake of 20% in BlackRock. Meanwhile, BlackRock is likely to rely on financing from Middle Eastern sovereign wealth funds. And Barclays’ president, Bob Diamond, is supposedly rumoured to be considering joining the board of the US-based BGI.

Larry Fink, BlackRock’s founder and chief executive, met the Kuwait and Qatar Investment Authorities last week to seek funding, according to the Financial Times.

The deal, if confirmed, would set a record for the acquisition of an asset management company, dwarfing the US$ 8.5 billion paid by BlackRock for Merrill Lynch’s fund arm in 2006.

It would also trigger a payout of US$ 585 million for the 200 employees of BGI with stakes in the company, with Diamond set to receive around US$ 30 million.

Although weekend press reports suggested that a new deal is close to being reached, Barclays has another 10 days until the June 18 deadline for seeking further bids for iShares and other related businesses.

This was set as part of the US$ 4.2 billion May agreement to sell iShares to CVC Capital Partners. CVC will receive a US$ 175 million break fee if Barclays concludes a transaction with a third party, as now seems likely.

A BlackRock acquisition of BGI would mean intensifying competition in the fixed-income ETF market, according to some observers. Last week Pimco, BlackRock’s biggest riva,l initiated its ETF range with a 1- to 3 -ear US Treasury bond tracker, undercutting the equivalent iShares fund with a 9 basis point annual fee.

-- IndexUniverse.eu's Paul Amery submitted this report. IU.com's Murray Coleman also contributed.

* Citigroup (NYSE:C), no longer among the DJIA components, is reportedly ready to restart last week's delayed $58 billion stock swap

* Apple's (NASDAQ:AAPL) worldwide development conference this week promises heightened attention for a major new product announcement of a lower-priced iPhone, priced at either $149 or $99, compared to the current low end of $199, with expectations that Steve Jobs would make an appearance.  Apple has closed higher over the past nine consecutive trading days.

* According to the International Air Transportation Association, global airline losses are expected to reach $9 billion this year, almost twice its projections three months ago, due to rising fuel costs and weak demand

* General Mills (NYSE:GIS) raised its 2009 earnings guidance by several cents from prior estimate of between $3.87 to $3.89 per share

The story, by veteran journalist Douglas Appell, said that BlackRock is expected to announce shortly that it would be BGI's new owner. The article cited unnamed sources.

Someone not connected directly to the deal told Appell that word of an agreeement likely will come within days.

Sources also told P&I that CVC Capital Partners, which originally agreed to pay $4.5 billion for BGI's iShares exchange-traded funds business, would get an opportunity to raise its original bid.

The CVC deal had a window for BGI to shop itself unti June 18. A P&I source thought it was unlikely that CVC would be willing to top BlackRock's $10-billion plus offer for the combined BGI franchise.

P&I estimates that a joining of BGI and BlackRock would create the world's biggest instititutional money manager with more than $2.2 trillion in assets.

You can read the full story here.

Your blog post on the topic smacks of desperation. The deal would "give Vanguard scale with intermediaries"? Please. Vanguard's already building a nice intermediary business with its portfolio of 39 ETFs, thank you very much, and they don't want/need another 150 products to sell.

The challenge of rationalizing those product lineups would be immense, and the numbers just don't work for me. And as you so rightly point out, the ultimate question is how such a deal would benefit existing Vanguard shareholders, who own the firm. The answer is it wouldn't.

What would make more sense—and something that Dave Nadig and I discussed briefly on our weekly podcast—is for Vanguard to swoop in and pick up the pieces of BGI after someone else carves out the iShares brand. The core BGI business would fit nicely into the Vanguard model, and help give it increasing scale and heft.

But iShares? Sorry.

BTW: By my calculations, the "go-shop" window for BGI ends two weeks from today. Barclays promises an update at that point.

Also: Impressive first day for Pimco's new ETF, trading 300K shares. Whether it can hold that volume remains to be seen, but it shows that people are taking Pimco's entry into the ETF space seriously.

* Take-Two (NASDAQ:TTWO) beat estimates with a fiscal second quarter loss of 4 cents a share, ex-items, as revenues declined 57.4% year-over-year to $229.7 million, versus estimates of $218.5 million. The firm issued downside third quarter guidance, but mixed fiscal 2008 guidance, anticipating full-year results of breakeven to a 20 cents a share profit ex-items, versus Street estimates of 12 cents, on revenues of $1.05 billion to $1.15 billion, versus estimates of $1.17 billion

* Barclays (NYSE:BCS) lifted 2010 estimates for Qualcomm (NASDAQ:QCOM) and Broadcom (NASDAQ:BRCM), expecting the two to benefit from increased market shares

* AutoZone (NYSE:AZO) reported a better-than-expected fiscal third quarter earnings of $3.13 a share, beating by 24 cents, as revenues increased 9.3% year-over-year to $1.7 billion

* Staples (NASDAQ:SPLS) released first quarter earnings of 22 cents a share, beating estimates by one cent per share on in-line revenues of $5.8 billion

As reported earlier by IndexUniverse.com, new actively managed iShares exchange-traded funds are  being planned by Barclays Global Investors. 

The prospectus for the first of the proposed new iShares funds has been filed with the Securities and Exchange Commission. Dated May 15, the new ETF would be focused on foreign currencies. It would implement absolute return strategies by investing in long- and short- positions in foreign-currency forward contracts and exchange-traded futures contracts.  

Barclays Global Fund Advisors will serve as the ETF's adviser and select the contracts to be used based on quantitative models and other proprietary methods created by BGFA. 

The proposed currency ETF would trade on the NYSE Arca exchange with the ticker "ALT."

You can read about the original filing, as well as plans for more active ETFs, here.

The full prospects can be found here.

BGI Sale Would Provide Big Boost To BlackRock, BNY Mellon

As negotiations continue on the sale of Barclays Global Investors, the two most widely discussed potential bidders—BlackRock Inc. and the Bank of New York Mellon—stand to gain a large immediate boost in assets if either one wins.

This Bloomberg News analysis pinpoints just how big each would become in terms of assets and the potential impact on the exchange-traded funds marketplace.

You can read the story here.

Arnott Article On Bonds Stirring Debate

In today's Wall Street Journal, John Spence explores the debate stirred by Rob Arnott in his recent Journal of Indexes story about the long-term benefits of bonds as opposed to stocks.

The story, which originally appeared at MarketWatch.com, talks to others who take the opposing side.

If you're a subscriber to the WSJ, that story can be found here. If you're not, a free version at MarketWatch is here.

Taiwan To Get Shanghai Listing?

Also in the WSJ, this short piece from last week notes the possible impending listing of Taiwan in mainland China.

It's something that has been rumored for awhile, but the WSJ found a Chinese official who was willing to talk about it on the record during a recent conference.

You can read the story here.

* Today's WSJ reports a number of insurers have received approval for up to $22 billion in TARP funds. The companies include: Hartford Financial Services (NYSE:HIG), Prudential Financial (NYSE:PRU), Lincoln National (NYSE:LNC), Allstate (NYSE:ALL), Ameriprise Financial (NYSE:AMP) and Principal Financial Group (NYSE:PFG)

* Barclays (NYSE:BCS) is reportedly in talks to sell its Global Investors division, with BlackRock (NYSE:BLK) and Bank of New York Mellon (NYSE:BK) named as possible suitors

* Abercrombie and Fitch (NYSE:ANF) reported a first quarter loss of 31 cents per share, which missed Street estimates by 17 cents, as revenues declined 23.5% year-over-year to $612 million

WisdomTree added another exchange-traded fund Wednesday to its lineup of actively managed currency funds.

The WisdomTree Dreyfus Emerging Currency Fund (NYSE Arca: CEW) made its official debut. The ETF provides exposure to a wide range of emerging market currencies. Those include: the Brazilian real, Chinese yuan, Chilean peso, Indian rupee, Israeli shekel, Mexican peso, Polish zloty, South African rand, South Korean won, Taiwanese dollar and Turkish new lira.

The firm already has eight currency ETFs, all but one of them marketed under the "WisdomTree Dreyfus" brand; this is the first of its funds to include multiple currencies bundled together. It charges an expense ratio of 0.55%.

"CEW should be attractive to investors interested in diversifying outside the U.S. dollar or accessing a less correlated asset class," said Bruce Lavine, WisdomTree's president, in a statement.

According to information provided by WisdomTree, the fund equal-weights as many as 12 different currencies, selected according to liquidity and economic as well as regional diversification.

Of the regions that the currencies fall into—Latin America, Europe, Asia as well as the Middle East and Africa—none can represent more than 45% of the fund upon rebalancing.

WisdomTree believes that equal-weighting the individual currencies reduces investor exposure to the volatility and other risks associated with emerging markets.

Since it's actively managed and not tied to an index, the fund can replace any of its component currencies at will, should its managers see the need—a potentially useful benefit with emerging markets, where governments and economic trends are sometimes more unpredictable.

As with all its currency funds, WisdomTree emphasizes that CEW is not a money market fund. But it invests primarily in U.S. money market securities and local currency forward contracts; the portfolio's average maturity is 90 days or less.  

In terms of taxation, WisdomTree says normal capital gains rules will apply to the sales of fund shares. However, income from the portion of the fund invested in U.S. money market securities usually will be taxed as ordinary income, while the tax treatment of the local currency forward contracts could vary with the situation. 

CEW is not the first exchange-traded product to provide access to a bundle of emerging market currencies. Barclays markets three exchange-traded notes covering multiple emerging market currencies; however, many investors have turned away from ETNs in the wake of the credit crisis.

CEW is also cheaper than the Barclays ETNs, which charge annual expense ratios of 0.89% each.

You can read the prospectus for CEW here and a statement of additional information here.

-- This report was submitted by IndexUniverse.com's Heather Bell. 

CVC To Keep Staff At BGI?

In this column by Kathleen Pender of the San Francisco Chronicle, Barclays Global Investors' impending deal with European private equity player CVC Capital Partners is reviewed. BGI insists that the new parent won't slash current staffing levels. 

But others aren't so sure, figuring that CVC will streamline operations and unload it during the next bull market. Just a thought ... what if that turns out to be fairly soon? Private equity firms can move fast ... but later this year or even next would seem awfully fast, even for the most optimistic and aggressive speculator. 

You can read the column here.

Bogle Takes On Institutional Money Managers

Vanguard founder John Bogle is raising an interesting point these days.

As noted in this New York Times column by Gretchen Morgenson, the indexing pioneer is pointing out that much of Wall Street's excesses resulting in a real estate boom and ongoing credit crisis can be traced to institutional money managers feeding the frenzy for cheap credit and leveraged financial instruments. 

You can read the column here.

Bill Gross Raises U.S. Holdings

Bond mutual fund manager Bill Gross increased his stake in U.S. issues during March to the highest level in two years, according to this Bloomberg News story. That was through the $144 billion Pimco Total Return Fund (PTTAX).

You can read the story here.

Investors can find such funds by checking out the entire list of the Zacks #1 Rank Government Fixed-Income Funds list.

3 Excellent Picks

AIM U.S. Government A (AGOVX) seeks high level of current income consistent with safety of principal by investing in U.S. government securities. The fund pays dividends monthly and distributes long-term and short-term capital gains annually.

Unit holders have to make a minimum initial investment of $1,000 to enter this Zacks#1 Rank ("Strong Buy") fund. It has an expense ratio of 1.06%.

Clint Dudley has been the lead manager at the fund since January 2009.

Allegiant Government Mortgage A (ARSAX) was incepted in November 1992 and seeks to provide current income as well as preservation of capital by investing in securities issued or guaranteed by the U.S. government.

The fund invests primarily in U.S. agency mortgage-backed securities and other obligations issued by the United States government. The dollar-weighted average maturity of the portfolio is expected to range from three to ten years. The fund's duration is expected to remain within 10% of its benchmark index, the Barclays Fixed Rate Mortgage-Backed Securities Index.

The fund offers dividends monthly. Capital gains, if any, are distributed annually.

Fidelity Advisor Government Income A (FVIAX) normally invests the fund's assets in U.S. Government securities and instruments related to U.S. Government securities.

The fund normally invests at least 80% of the assets in U.S. Government securities and repurchase agreements for those securities. Currently, FVIAX does not intend to invest more than 40% of the assets in mortgage securities. The fund distributes dividends monthly.

William Irving has been the lead manager at the fund since January 2007. FVIAX has an expense ratio of .81%. Unit holders have to make a minimum initial investment of $2,500 to enter the fund.

Discover Many More Funds

Learn more about the new Zacks Mutual Fund Rank and discover some of the best market-beating mutual funds by browsing our new mutual funds section. This part of Zacks.com offers a variety of tools, including mutual fund research, a new mutual fund screener, helpful answers to frequently asked questions and quick access to prospectuses and other information.

By applying the Zacks Rank to mutual funds, investors can find funds that not only outpaced the market in the past but are also expected to outperform going forward.

Sounds too easy, right? But take a look. Using data as of March 31, the 10 largest ETFs by assets were:

If you took an equal position in each of those ETFs, you'd have a nice, balanced portfolio: 60% stocks, 30% bonds and 10% gold.

Not only is that a reasonably well-diversified portfolio, it includes a number of twists and tilts that I find pretty appealing right now.

Starting in equities, both growth and large-caps have been performing relatively well, as they often do in difficult economic environments. Similarly, the tilt toward Technology via the QQQs captures one of the best-performing sectors in the market. And while the portfolio is light on international exposure, its strong relative weight in emerging markets is appealing.

In the fixed-income market, it is almost dead-on. If you split out the exposure in AGG, the fund is 16% corporate, 10% TIPS and 4% Treasuries. Considering that most experts think that Treasuries are at least fully valued, and corporate undervalued, that's just about right. 

Finally, the addition of significant (20%) exposure to inflation-hedging assets like gold and TIPS is very appealing in the current environment, where many of us (even Jim) expect a major uptick in inflation.

Another approach would be to create a portfolio weighted by the size of assets held in each ETF. That portfolio is slightly more aggressive, with 68% equities, 16% bonds and 16% gold.

As good as these portfolios seem to be, I'm tempted to look a bit further down the tables to see what other ETFs are on the edge of being added to the mix.

Looking through that list, there are a few tempting funds. I love the Vanguard MSCI Total Market ETF (NYSE Arca: VTI), the cheapest way to gain access to the total market. And I'd be very tempted to elevate the iShares FTSE/Xinhua China 25 ETF (NYSE Arca: FXI) into the mix, as I think China is underweight in global benchmarks and is positioned well to perform.

Still, that's all happening on the edges. You don't really have to go much further than the top 10. As it turns out, ETF investors are a pretty smart lot. So much for the madness of the crowds.

Recent filings by London-based ETF Securities (ETFS) indicate that U.S. investors may soon be able to access two precious metals via products structured in a way similar to the SPDR Gold Shares ETF (NYSE Arca: GLD). The ETFS Palladium Trust and the ETFS Platinum Trust each will hold physical bullion of their respective metals.

Palladium and platinum futures are traded in the U.S., but currently there are no exchange-traded funds covering the two elements. Barclays offers the iPath Dow Jones-AIG Platinum exchange-traded note, but it is a credit note, and does not take physical positions in the underlying metals. The ETF Securities products should appeal to investors looking for investment vehicles with tangible assets.

A few years ago, there were rumors that a bullion-based platinum ETF was being developed in the U.S. At the time, however, there were concerns that the market for platinum was too thin, and that hoarding by the ETF would create a shortage in the physical metal, which is used in everything from catalytic converters to jewelry.

At least one platinum mining firm came out against the concept, worrying that hoarding would drive up prices in the short term and hurt long-term industrial demand. With commodity prices (and demand for platinum and palladium) down, however, those worries appear to have gone away.

ETF Securities already offers platinum and palladium bullion ETFs in Europe.

The most recent filings bring the number of ETFS products in registration with the SEC to four—all of them trusts that will hold precious metals (silver, gold, palladium and platinum). Although the silver and gold trusts will compete directly with offerings from State Street Global Advisors and Barclays Global Investors, the palladium and platinum products will likely be the first ETFs to cover their respective metals.

ETFS offers a wide variety of commodity-based products—what it terms "exchange-traded commodities," or ETCs—on multiple exchanges in Europe. It has yet to launch any products on the U.S. market.

Read the filing for the ETFS Platinum Trust here.

Read the filing for the ETFS Palladium Trust here.

In a dazzling turn of events that made the FT, IndexUniverse.com's Matt Hougan and many others pawns in a brilliant smoke-and-mirrors act, with most industry observers believing that private equity firm CVC Capital had made a successful bid to buy the iShares unit, the SSgA deal was made public in London this morning.  The CVC purchase would have provided cash-starved Barclays bank with an infusion of funds and a separation of the share-lending business from the overall deal. The SSgA deal provides more capital, though it will be financed at 80% by iShares, and no Barclays upside in the new enterprise.

The previously announced deal had struck some experts as somewhat shocking and unlikely, as bids which included the share lending business had already topped $6 billion, according to sources with knowledge of the bidding process, while the CVC Capital bid was just £3 billion ($4.3 billion).  The CVC deal had Barclays reportedly funding some 60-70% of the purchase and keeping a 20% stake in the new enterprise. This deal had seemingly placed an enormous $1 billion-plus value on the share lending business associated with the exchange-traded funds (ETF) family. If true, these differences would have provided a window of transparency into the value of the opaque securities lending business.

Ex-Barclays Global Investors employee Tony Rochte, now at State Street Global Advisors (SSgA), who was instrumental in brokering the deal, noted that in SSgA's custodian role, it would be able to best benefit from the enormously profitable share lending business. In a concession to StreetShares/iDRS investors, Rochte noted that the new entity would be giving 55% of share lending revenues to fund investors (up from the 50% iShares had been passing through to end-clients) and would "still come out ahead with the new efficiencies of the funds integration."

Lee Kranefuss,now CEO of the iDRS side of the business (which will include the highly profitable international and alternative assets part of the new unified funds family) announced a plan to lower all iDRS expense ratios to 1 basis point below all equivalent Vanguard funds in an effort to "put an end, once and for all, to competition in the ETF business." Vanguard had reportedly also made a bid for the iShares unit.

Look for more information about the iShares deal sometime after the April 1^stholiday.

That's right, it's (almost) official: Barclays issued a statement this morning confirming reports in the FT and elsewhere that its iShares unit was likely being sold to CVC Capital Partners. The Barclays statement read:

Barclays notes recent press comment regarding a possible sale of iShares. As announced on 16 March, Barclays has held discussions with a number of potentially interested parties.

We now have a preferred bidder, CVC Capital Partners. If these negotiations reach a satisfactory conclusion, it would lead to a sale of Barclays iShares business without the attributable securities lending business. Earlier speculation assumed the sale of both iShares and securities lending.

A further announcement will be made in due course.

So much for Jim Wiandt's recent blog, which was titled, iShares Sale Not Happening – Yet.

I'm surprised that Barclays is willing to shop its crown jewel in such a difficult environment. The sale was originally being driven by reports that Barclays had to raise capital to avoid partial nationalization. But the British government subsequently conducted a stress test on the company, and found that no new money was needed, obviating the need for the fire sale.

For Barclays to go anyway is surprising. They must feel that they are getting a fair price from CVC; also, all the Barclays executives with shares in BGI must be feeling pretty excited about the payout. Otherwise, what's the rush in the current climate?

The deal could still fall apart, of course, but it's sure not looking that way now.

Who Is CVC Capital Partners?

According to its Web site, CVC Capital Partners is a Luxembourg-based private equity firm that's been operating for 27 years. The company says it "focuses on building businesses over the long-term, typically holding investments for five years or more."

Interestingly, the firm doesn't appear to have any investments in the financial services space. Its complete portfolio of 52 companies is listed here, and includes such brand names as the aforementioned Formula One, as well as a variety of industrial companies like Smurfit Kappa Packaging and significant retail brands like Samsonite, Skylark and Tower Records.

That's not to say that CVC won't do a good job driving iShares forward. It's a big outfit that has delivered strong returns for many years, and can certainly adapt to the financial services space. But it makes this already-unusual deal all the more unusual.

Three private equity groups have apparently emerged as the finalists in the auction of exchange-traded funds leader Barclays Global Investors.

According to a report in the Financial Times dated March 31, parent Barclays rejected bids for BGI from Goldman Sachs and others.

The paper says that the London-based bank considered offers turned in last Friday to be insufficient and offered to accept revised proposals on Monday. 

Goldman Sachs and others dropped out, according to the report by Jane Croft and Martin Arnold. The story indicated that those opting not to continue in the auction process were unwilling to meet Barclays' demands of at least $6.5 billion for BGI.

The paper also reported that a trio of private equity groups did resubmit bids. Those came from: Bain Capital and Colony Capital; Hellman & Friedman and Apax Partners; and CVC Capital Partners.

The report also noted that it could take another week for a deal to be hammered out considering its complexity and Barclays' willingness to help finance part of any agreement. 

You can read the full story, which also has more on the state of the bank's overall financial situation, here. 

Salvatore Bruno is chief investment officer at IndexIQ Advisors LLC. Prior to joining the asset manager and index provider, he was a portfolio manager at Deutsche Asset Management. Before that role, Bruno was the head of advanced quantitative research at DeAM.

On Thursday, IndexUniverse Managing Editor Murray Coleman caught up with the busy CIO traveling in Philadelphia. Among other topics, they discussed the firm's launch of the first exchange-traded fund to mimic hedge fund strategies. That's the IQ Hedge Multi-Strategy Tracker ETF (NYSE Arca: QAI), the first exchange-traded fund to mimic hedge fund strategies. (See article here.)

IU: Is the new ETF taking a totally passive approach?

Bruno: It's fair to say that this is a rules-based methodology. But it does rebalance more than a traditional passive investment. It rebalances every month. But it's passive in the sense that it doesn't incorporate subject views on where assets should be allocated.

IU: Does the ETF follow a similar index as the mutual fund created by IndexIQ last year?

Bruno: It is similar in terms of methodology. But given the differences in the regulations between a 40-Act mutual fund and an ETF, there are some slight differences. But the underlying processes are the same.

IU: You've created essentially six different subindexes based on different hedging strategies. How do you decide weightings for each subcategory?

Bruno: The weightings are a result of a proprietary rules-based optimization process. We look at trailing returns of each of the six strategies. And we compare the level of returns, volatility and correlation of each of those strategies to a broad hedge fund index. That broad index is the CS Tremont Non-Investable Hedge Fund Index. Then we find the best combination of the strategies to achieve our objectivity of high returns, low volatility and high correlation to hedge funds.

IU: What are the weightings to each strategy in the ETF now?

Bruno: The weights are approximately 33.33% each in equity market-neutral, fixed-income arbitrage and event-driven strategies. We also have a -16.67% on long-short, and the remaining weights are split among global macro and emerging markets. The specific ETFs we're holding and their weights are posted on our Web site daily. [See table below for QAI's complete holdings.]

IU: How are ETFs used to represent different asset classes held by hedge funds?

Bruno: We're looking for ETFs that meet minimum liquidity and asset size requirements to make sure they're truly investable. Then, we look at asset class exposures and risk premiums of hedge funds. So we're trying to find the optimal ETF or combination of ETFs that match up the closest to those asset class and risk premium exposures of hedge funds.

IU: Does the ETF take on similar characteristics of a 130/30 hedge fund?

Bruno: The ETF will not because it doesn't have any short positions in its portfolio. We do, however, use inverse ETFs to generate short exposures. That's different from the mutual fund, which actually shorts securities and uses proceeds from those transactions to go long. This is a prime example of the difference in implementing basically the same strategy but in different vehicles—a mutual fund compared to an ETF.

IU: In a nutshell, what exactly are you trying to deliver with this new ETF?

Bruno: We're trying to provide a vehicle that will give investors access to risk-adjusted returns similar to those of hedge funds. We're also trying to provide similar levels of diversification to broad equity markets.

IU: How noncorrelated is this ETF's benchmark to the broader stock market?

Bruno: The CS Tremont index has a correlation of between 50-60% to the S&P 500. We expect our ETF to have similar levels of correlation to the S&P 500. We have live returns on the IQ Multi-Strategy Index since 2007. But including live and backtested returns, it has generated about a 4.86% average annualized return in the past five years through February. And during that same period, the average annualized volatility is less than 6%. By comparison, the S&P 500 returned -6.63% with significantly greater volatility.

IU: With slightly more than 9,000 hedge funds in the U.S., how can you accurately categorize all those funds into six distinct styles?

Bruno: We've chosen to outsource that level of analysis to CS Tremont and Hedge Fund Research Inc. We work with data at the strategy level, not at the fund level. That's an important point because at the fund level, there's a lot of specific fund manager risk, which is difficult to model. We're actually able to better identify the common factors driving hedge fund returns without being distracted by the noise of manager-specific risk.

The Complete Portfolio Of QAI (Through March 25)  

We've got Matt Hougan and John Spence and Chuck Jaffe and the Wall Street Journal—and now even Murray Coleman all jumping in and speculating on what's going to happen with iShares. The truth is that none of them know—and even the people over at BGI probably don't know. But I do.

I just don't see it happening. Or rather, I do think that an eventual separation has become exponentially more likely ... I just don't think it happens immediately. 

First of all, let me point you to the best blog on the topic yet. It's Paul Amery's blog from over on the http://www.indexuniverse.eu/ site. Here are the Cliff's Notes^TM of what Paul covered in his blog that few others have hit upon:

1. Barclays needs to tell the U.K. government whether or not it plans to take the Queen's money in her "save the world" scheme. That's a week from today. A week. And Barclays needs the (~$4 billion) that would be raised by selling iShares to avoid being the Queen's, uh, lady dog friend as I put it in MY .eu blog (the editorial staff edited that out. Probably that prude Hougan. I know it wasn't Paul, because his clever allusion to my reference talking about the "Queen's Corgis" was not itself edited out). Anyway, I'd like to see you, say, try to sell your house for top dollar in this market-in a week. That's why it probably won't happen immediately.

2. But there are lots of reasons why it might well happen. For starters, in the BGI group, there is HUGE internal ownership (of about 6%) and an enormously generous profit-sharing scheme that:

a) Makes Barclays want to get rid of that ownership;

b) Might have the BGI guys incentivized to get while the getting is good. After all, they could potentially run their own business, which may well be appealing to Lee Kranefuss, after being tacitly passed over in the grooming for the next head of the Big Bank); and

c) Encourages the employees to push for getting a cash and ownership payout now, instead of leaving themselves at the whims of an angry public while working in a state-owned enterprise? Would you prefer "anything goes" or "beneficial ownership in my own company"?

3. Clearly Barclays is an EAGER seller and is working very hard to try to make this sale happen, even offering to finance almost the entire purchase price, according to an excellent Wall Street Journal article from a couple days ago.

4. Finally, as Paul pointed out, a "death spiral convertible" (love that term) dilution clause was grantedby Barclays to its Abu Dhabi and Qatari investors in October. So it would come as no surprise whatsoever if some of those same Middle Eastern investors were involved in the private-equity-led consortium to buy iShares.

Despite all that, in this market and with that time frame, I just don't see it happening. I've put out a headline that makes me look foolish if the iShares deal does go through within the next week—which it well could if all the effort going into this deal is any indication. So I'd look dumb, but it could be no match for Hougan's horror-show USO-USL bungle (which I'll never let him forget).

But the seed has indeed been planted (and not for active management as Chuck Jaffe misquoted me as saying in his column—though I did say I think active is coming to iShares regardless). I said the seed had been planted for a separation of the iShares franchise from Barclays at some point. Only time will tell if the opportunity could have never been better.

That shouldn't come as a big surprise to those following the next evolution of a changing iShares brand.

In case you missed it, weekend stories in papers ranging from the Wall Street Journal to the Sunday Times reported that a list of finalists has emerged in the auction of Barclays Global Investors by its parent London bank. Insiders are indicating that Hellman & Friedman LLC could wind up as the leading candidate to assume control of BGI.

As pointed out in the WSJ, that's a private equity firm also based in San Francisco with a history of past relations with the asset manager. Other possibilities, according to the paper, are Bain Capital and other private equity rivals such as TPG and Apax Partners LLP.

Although we've heard some industry veterans arguing against such a scenario—that larger, more-diversified fund companies and brokerages are the more likely eventual winners—the push by private equity players actually makes a lot of sense.

First, the strength of the iShares brand among retail investors might provide a nice counterpoint for a private equity firm, which derives most of its investment flows from institutional investors. Private equity companies are also deeply familiar with the ETF market, as they've proven to be cutting edge participants in the ETF marketplace on the institutional side.

When you add in the fact that the core business of private equity is to capitalize on short-term market dislocations, you can see why a private equity bid for iShares would make sense. As IU.com Editor Matt Hougan told Dow Jones Newswires recently, while iShares is a very attractive asset, most of the obvious bidders are tight on cash. A private equity firm could buy iShares today, run it for a few years and then unload it into an improved market.

Whatever happens, iShares is likely to change, shaking off some of the rust and moving into new ventures. In fact, IU.com Publisher Jim Wiandt thinks its new owner is probably going to be someone who wants to take BGI's existing index-based ETF franchise and expand upon that framework.

In a MarketWatch column by Chuck Jaffe that showed up this weekend, Jim noted that "active is going to happen at iShares; it's a seed that has been planted."

In a recent conversation I had with Lee Kranefuss, the chief executive officer of BGI's iShares business hinted at the same. He explained that BGI was a leader in institutional management of enhanced indexing and other related quantitative strategies that were more active in nature, and that BGI has been studying how a more active sort of ETF could leverage the work done within other parts of the company.

Whether that initiative would be scuttled or delayed by a sale remains to be seen. But recent reports indicate that BGI may want to maintain up to 20% of iShares in any sale.  You can bet that any buyer is probably interested in what BGI is doing in the active space.

And just when you thought you'd seen about all there was to see in the ever-changing world of ETFs ...

More On BGI's Fate

The Wall Street Journal this morning had more on the surprise move by the parent of Barclays Global Investors to hire an investment banker to shop the industry's biggest ETF provider. 

You can read the story here.

Closing Of MarketGraders Will Make It 17 This Year

In an interesting blog at MarketWatch.com about the closing of SPA's MarketGrader ETFs, John Spence notes an analyst report that puts the number of announced closings for ETFs at 17 so far in 2009. 

You can read the story here.

The Name Game Begins

In another blog, Spence does a roundup of stories speculating on potential suitors for BGI.

Even though MarketWatch is part of Dow Jones, he provides links to stories by Bloomberg and Morningstar on the same topic.

You can read the story here.

Top-Rated Commodity ETFs

In this analysis by TheStreet.com, Richard Widows takes a look at how some parts of the commodities market is faring better than others. In particular, he singles out some of the more attractive ETFs. 

You can read the story here.

I know my more serious colleagues—Jim Wiandt and Murray Coleman—will accuse me of falling short of the desired journalistic reserve. To that, I plead guilty. The list of potential suitors I lay out below is rank speculation, based on nothing more than my intuition about the industry and a few silly hunches.

But the fact that Barclays is shopping iShares around is big news in the ETF industry. There are important ramifications. And besides, this is a blog, and if I can't speculate here ...  

So let's get it out of the way. Here is my list of potential suitors. This is borrowed from my own speculation, and that reported by John Spence and others in the media yesterday:

• Big Broker-Dealers: Goldman Sachs, J.P. Morgan, Morgan Stanley
• Big Banks: State Street, Deutsche Bank, Northern Trust
• Brokers: Charles Schwab
• Fund Companies: Fidelity

There are a dozen more options, including private equity firms, but those are some of the hot names.

Make no mistake: iShares would be a jewel for any of them. It controls 46% of all ETF industry assets, including six of the top 10 funds. Its iShares MSCI Emerging Markets ETF (NYSE Arca: EEM) is the second-highest grossing ETF in the world, pulling in over $110 million per year; only the SPDR Gold Shares (NYSE Arca: GLD) does better, grossing $125 million. And it sits at the heart of one of the fastest-growing segments of the financial services industry.

Whoever buys iShares, assuming it's sold, I hope for one thing: They continue pouring money and effort into educating investors about ETFs. The ETF industry has been built in large part on the outreach efforts of iShares, and it would be a shame to lose that.

(Editor's Note: The following is an edited excerpt of an article from February's edition of the Exchange-Traded Funds Report. Subscribers can read the full story here.)

As markets continue to slide, many advisers are suggesting that investors play it safe. In the world of fixed-income, that means staying on the short side of the duration curve to avoid the threat of rising interest rates.

In the past 18 months, as the world's credit crisis has spread to stocks, a number of options have come to market for exchange-traded fund investors. Those looking for short-term bond ETFs can now find several different portfolios to choose from. 

Treasury Bond ETFs

The "granddaddy" of the short-term bond ETFs comes-no surprise-from Barclays Global Investors. The iShares Barclays 1-3 Year Treasury Bond Fund (NYSE Arca: SHY) dates back to July 2002, and had $7.69 billion in assets at the end of 2008. For all intents and purposes, its portfolio consists entirely of Treasury notes. It had more than 40 holdings as of year-end 2008. According to iShares, SHY had an average weighted maturity of 1.82 years.

The fund was the second-best performer in the group in 2008, up 6.61%. It had 3-year and 5-year annualized returns of 4.78% and 3.94%, respectively. SHY charges an annual expense ratio of 0.15%.

Another iShares fund is also a heavy hitter in the group and holds bonds with even shorter maturities. The iShares Barclays Short Treasury Bond Fund (NYSE Arca: SHV) had about $1.57 billion in assets at the end of 2008. Created in early 2007, it was up 2.84% in 2008. It holds 13 different Treasury notes and has a weighted average maturity of just 0.39 years. Its components have durations ranging from just one month to a year.
The fund charges 0.15% in management fees.

The SPDR Barclays Capital 1-3 Month T-Bill ETF (NYSE Arca: BIL) holds bonds with maturities ranging from one to three months. Its average maturity is just 0.14 years. This extremely short-term bond fund has just 10 holdings (all Treasury bills). BIL ended 2008 up 1.53%, with $743 million in assets. The fund charges 0.13%, making it one of the cheapest ETFs in this comparison. If you want safe, you've got it with BIL.

Diversified Short-Term Bond Index ETFs

Of course, if you're willing to diversify away from Treasuries, you can take on short-term corporate debt and perhaps look for a bit more yield. Right now, because of concerns about the short-term market, you get a lot more yield.

The largest fund in this category is offered by Vanguard. The Vanguard Short-Term Bond ETF (NYSE Arca: BSV) is the ETF share class of a much larger fund, with more than $9 billion in assets, of which BSV represents about $1 billion. The fund tracks the Barclays Capital U.S. 1-5 Year Government/Credit Bond Index. It holds a mixture of government, corporate and international dollar-denominated debt. The index has almost 2,000 components, but BSV only holds about half of that number. Government or agency debt represents nearly 70% of the portfolio.

The fund has an average maturity of 2.8 years and typically a significant jump in yield from the Treasury ETFs. BSV is the cheapest of the funds in this comparison, with an expense ratio of just 0.11%.

The iShares Barclays 1-3 Year Credit Bond Fund (NYSE Arca: CSJ) is a pure-play on short-term corporate debt, avoiding Treasuries altogether. The fund ended 2008 with about $793 million in assets. Last year it rose 3.85%. The portfolio is dominated by corporate debt from the Financial (33%) and Industrial (32%) sectors, as well as non-corporate debt (27%). While the underlying index includes 581 components, the fund is optimized, with fewer than 120 holdings. CSJ has an average maturity of 1.95 years and usually reflects the higher yields available in the corporate market. The fund charges 0.20%.

ULQ ended 2008 with about $6 million in assets. It charges 0.27% in annual expenses, making it one of the most expensive ETFs in this survey.

Actively Managed ETFs

Some believe that the opaque credit markets lend themselves to active management, where savvy buying and credit-picking can improve returns. Two of the ETFs in the short-term bonds category are actively managed and were introduced in 2008.

The WisdomTree U.S. Current Income ETF (NYSE Arca: USY) is the larger of the two, with about $21 million in assets at year-end. It invests primarily in very short-term, investment-grade debt.

WisdomTree does not label it as a money market fund, and it is not insured by the FDIC, as true money market funds are at this point. Still, many consider it to be effectively a money market fund. Its largest component is a federal home loan discount note that represents roughly 35% of the portfolio. The fund charges 0.25% in annual expenses.

The PowerShares Active Low Duration Fund (NYSE Arca: PLK) is the smallest fund in the group, with just about $3 million in assets at the end of 2008. Its portfolio consists mainly of U.S. government, corporate and agency debt, with roughly 96% of the portfolio invested in securities with maturities of five years or less. The portfolio currently includes 21 holdings.

In addition to being the smallest fund in the group, it is also the most expensive, charging 0.29%. Expanding out the yield curve, however, it tends to pay higher interest rates.

Oil ETF Grows Too Big?

The enormous growth of the U.S. Oil Fund (NYSE: USO) since the second half of last year has made it difficult for the fund to hide its monthly automatic rollover in front-month contracts, according to this Dow Jones News Service story.

On Friday, it rolled over such a huge number that analysts are blaming it for influencing prices.

You can read the story here.

Dividend Focused ETFs

John Spence of MarketWatch takes a survey of ETFs that focus on dividends on the market.

You can read the story here.

More On Jim Cramer's Record

Considering you might've read on these pages last September Jim Wiandt's blog, "Why Jim Cramer's A Moron," how could we not bring the latest Barron's cover story?

It's titled "Cramer's Star Outshines His Stock Picks."  (Seeking Alpha has an interesting commentary about how this story differs from the magazine's last review of Cramer's record. It also notes that Barron's stock picks for 2008 did even worse. You can read that article here.)

You can read the Barron's story for free (thanks to MarketWatch) here.

This interesting article from BusinessWeek chronicles the work being done by asset managers including Russell Investments and others to develop a new type of 401(k) plan.

But most of the article tracks what's happening at Barclays Global Investors, which is considered among the most aggressive in moving forward with new programs. To make a long story short, these hybrid plans basically resemble target-date retirement funds with fixed deferred-income annuities serving as the bond component.

You can read the story here.