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.

Harry Dent is founder and chief executive of Tampa, Fla.-based HS Dent Investment Management LLC. He is a best-selling author and money manager who has developed quantitative investment models based on demographic research.

He took time on Tuesday to discuss his latest views on the market with IndexUniverse.com Editor Murray Coleman. They also discussed Dent's new exchange-traded fund, the AdvisorShares Dent Tactical ETF (NYSEArca: DENT). It's scheduled to begin trading on Wednesday. Below are excerpts of that conversation.

IU.com: You’re fairly pessimistic about the market now, aren’t you?

Dent: We do think we’re at the end of this rally. This isn’t like past recessions. Consumer spending by baby boomers is peaking. It’s the end of a long surge that began in the 1980s. Clearly, baby boomers are going to start saving more and spending less over the next decade. That’s going to deflate the whole economy. The next generation should start to pick up consumer spending levels again -- roughly around 2020. That’s when we’re expecting the start of another long-term boom.

IU.com: In the meantime, do you see many short-term opportunities for investors?

Dent: Right now, we’re still seeing a lot of hope priced into stocks for a prolonged recovery. But in 2010, we think markets are going to start falling again and people will become very disappointed. Our expectation is that stocks are heading towards an extended period, which will be marked largely by downturns and sideways movements. From late 2010 through around 2020, we’re expecting stock markets around the world to remain in a trading range with a lot of volatility. We’re expecting the S&P 500 to show a lot of ups and downs over the next decade, moving anywhere from around 300 to 1,100 as markets remain in flux throughout the period.

IU.com: That’s quite a range, isn’t it?

Dent: Yes, that is. The point is that we’re going to see a lot of volatility in the next 10 years. Under these conditions, we think you’ve got to play momentum – there’s not going to be another prolonged boom for awhile. But we do expect some markets to do better than others. When times are better, we expect places like India to roar a little more than most developed markets. Emerging markets, though, will remain extremely volatile. Eventually, somewhere around 2020, I can see us coming out with another ETF that plays strictly in emerging markets. But in the shorter-term, emerging markets are still very dependent on developed markets. And Europe, as well as Japan, are practically dead at this point for investors looking for the best relative growth opportunities.

You’ve also got to remember that emerging markets have just been through one of the biggest bubbles in the past several years. So, there’s going to be a shakeout in the shorter-term in Asia and Latin America. The positive is that even in a sideways-moving global market, emerging markets will see bigger bounces than developed markets. Our model for the new ETF will likely lean towards countries like China and India and other emerging markets when momentum is moving up. We feel like that’s how you’ve got to play global markets in the next decade – with a lot of flexibility to take advantage of movements up while remaining cautious on the downside.

IU.com: In your latest book, you show different demographic trends favoring emerging markets over the next several years, don’t you?

Dent: The strongest demographic trends – countries with growing workforces and growing consumer patterns – are going to be in the emerging markets. Latin America and much of Asia is largely urbanized: India is a little over 30 percent; China is just under 50 percent but Brazil is over 80 percent. So, emerging markets' growth is very tied to this move towards greater urbanization.

IU.com: What regions or countries are behind the curve in terms of urbanization?

Dent: If you take away oil, the Middle East is largely a third-world region. And most of Africa is still struggling to become more urban. So, they’re more frontier markets now. But our new ETF is only interested in investing in countries clearly on the way up.

IU.com: What is your favorite country on a longer-term basis at this point?

Dent: If I had to pick one country for the next 30 to 40 years, it’d be India. It wouldn’t be China. Their demographics are going to work against them. After 2020, urbanization will come at a slower rate since younger people generally are the ones to move the fastest out of rural areas. China’s policy of one child per family, which started in the early 1970s, will begin to catch up with them between 2015-2020. Someone said China is going to get old before they get rich, and we agree with that. By contrast, India’s demographics won’t peak until about 50 years after those of China.

IU.com: Does the new ETF follow your basic investment process?

Dent: It is simply a momentum model we’ve tracked for years. But it’s different than what we’ve done in the 1980s and 1990s – the methodology we tried to use in the past with some of our separate accounts and the old AIM mutual fund.  We were subadviser to that fund and AIM just didn’t listen to us. The fund was supposed to be a blend of our models and those developed by AIM. But when markets crashed in 2000-2002 and our models were very cautious, the AIM models were favored and the fund remained quite more aggressive in stocks than our models preferred. That fund ended up getting merged into another one and we learned a valuable lesson: Joint ventures aren’t the best way to go with fund portfolios. We’ve got well-tested, momentum-based models and it’s either got to be our way or the highway in terms of working with fund portfolios.

IU.com: Is that why you decided to go with an ETF structure?

Dent: The ETF structure is very low-cost compared to similar hedge fund and mutual fund strategies. And they’re more widely available compared to hedge funds and mutual funds. Anybody can add our ETF to their portfolio. And we’ve got control over it and nobody else can tell us how to manage our investment model.

IU.com: Can you explain the process that this model follows?

Dent: This is a quantitative-based model. It looks at the universe of developed and emerging markets. It also includes commodities. So it has latitude to go anywhere. The key is how it decides to pull out of sectors and countries. The advantage of any momentum model is that when things are going well, the model does, too. But, of course, the difficulty is moving out of an area of the market, or back in, when things aren’t going so well. There’s always going to be a lag – you’d have to be a genius to time markets perfectly.

But this ETF’s model isn’t going to act like an actively managed hedge fund or mutual fund. This ETF will be on a monthly rebalancing schedule, so there’s going to be a lag time between shifts. So the key is going to be to get the general trends right. We’re not trying to time exact tops and exact bottoms. The model has some technical factors built into its methodology. But technical analysis isn’t always right. So, it also includes elements of fundamental analysis. We believe this is the best model for a market that’s heading towards an extended winter.

(Editor’s Note: The following is an excerpt from an article in the Exchange-Traded Funds Report in July. Subscribers to ETFR can read the complete piece here.)

Specialty-sector ETFs—also called “thematic” ETFs—have emerged as a major force in the ETF industry.

These ETFs run the gamut of investment possibilities, but have one thing in common: They look past traditional size and sector designations to carve out new investment areas, often driven by a single investment thesis.

Clean energy, infrastructure, nuclear power—by our count, there are now more than 40 of these unique ETFs on the market, with more than $10 billion in assets under management.

Investment manager Van Eck Global has been one of the most successful companies in carving out a foothold among specialty ETFs. Its Market Vectors Gold Miners ETF (NYSE Arca: GDX) is the largest specialty ETF of all, with almost $5 billion in assets.

“We’re looking for compelling investment themes that we believe in for the long term, where the ETF basket approach can be a great tool for market participants,” said Adam Phillips, managing director of Market Vectors, “whether that be for the buy-and-hold investors or the trading community.”

Of course, some investors see things differently.

Rick Ferri, founder of the advisory firm Portfolio Solutions and author of “The ETF Book,” calls thematic ETFs “gimmicky.”

“We don’t use any thematic funds in our management here,” said Ferri. Ferri, a former broker himself, believes thematic ETFs are less popular with independent advisers than they are with brokers for a simple reason: story. He says they are an easy sale to clients who can relate to specific areas like clean water or other environmentally motivated ETFs.

“They come out when they happen to be popular in the news,” Ferri said. He believes they do well as brokers buy them up (sometimes driving the actual price of the ETF up) but that they tend to fall off six to 18 months later.

Roger Nusbaum, portfolio manager and chief investment officer for financial planner Your Source Financial, disagrees.

“In terms of long-term investing and the context of diversified portfolios, I absolutely think there’s utility [in them],” he said. Nusbaum uses them, as well as individual stocks, in his sector-based approach to portfolio construction. He has used the PowerShares Water Resources Portfolio (NYSE Arca: PHO) in client accounts since its launch, for instance, saying he tends to incorporate it as part of the allocation to industrials.

With regard to price run-ups, Nusbaum says some specialty sectors can be “faddish” in their behavior. If a fund covering solar energy jumps by 50%, and you know the industry is not going to fully develop for years to come, he suggests it might be time to reduce your exposure until the price becomes more reasonable.

Slicing & Dicing Themes

One of the most common questions asked by investors is, “Which ETF covers this?” Indeed, it’s often hard to even know what specialty-sector ETFs are available, as by definition they fall into narrow categories unlikely to be highlighted as an “asset class” in the pages of the Wall Street Journal. With so many fund launches, it can be a challenge to simply keep up with what products are on the market.

With that in mind, we have compiled an overview.

Alternative Energy

Last year’s run-up in energy prices and rising concerns about peak oil have combined to dramatically increase investor interest in energy alternatives. From relatively diversified funds to those targeting just solar or wind, investors can now use ETFs to access energy alternatives in practically any flavor they like.

Largest ETF: The PowerShares WilderHill Clean Energy Portfolio (NYSE Arca: PBW) was the first and is still the largest of these ETFs, with $743 million in assets under management. Some consider its exclusive focus on U.S.-listed names limiting, as much of the alternative energy industry is focused abroad. But the fund gains some exposure to these markets via ADRs.

Coal

Coal is the cheapest source of BTUs on the planet, easily beating oil, gas, wind, solar, hydro and nuclear. In addition, both China and the U.S. have huge domestic supplies of coal, and spiking oil prices are encouraging further development of the resource.

Largest ETF: The largest coal ETF by far is the Market Vectors Coal ETF (NYSE Arca: KOL), with $277 million in assets under management. The ETF holds a global portfolio of coal companies, primarily focused on the mid-cap miner space. It is 49% exposed to U.S. companies, with other significant positions in China (23%) and Indonesia (15%).

Nuclear

The long-term case for nuclear energy is clear and clean: The underlying fuel is so plentiful that we will never run out of it, and, when operating safely, nuclear power plants produce zero emissions. Once built, nuclear power is also the cheapest kind of energy on the planet.

Largest ETF: Three ETF companies offer nuclear energy ETFs. The largest is the Market Vectors Nuclear Energy ETF (NYSE Arca: NLR), with $166 million in assets. The fund has a large position in uranium miners (40% of the portfolio), with other concentrations in power generators and plant construction companies.

Commodities

The commodities boom raised the profile of “stuff” as an investment, and ETFs have made the area more accessible. Specialty-sector funds often focus on companies that produce commodities, like water or steel, that do not have liquid futures contracts.

Largest ETF: The largest hard assets ETF is the Market Vectors Agribusiness ETF (MOO), with nearly $1.5 billion in assets under management. Close behind is the PowerShares Water Resources ETF (NYSE Arca: PHO), with $1.2 billion in assets. Other areas of the market include steel, timber and broad-based commodity stocks.

Infrastructure

The term infrastructure is nearly as sweeping as commodities; it covers everything from companies involved in the construction and repair of roads and bridges to those that build and maintain power grids, telecommunications networks, and sewage systems. There’s no denying that infrastructure is a big deal these days: Developed countries desperately need to restore aging systems, and emerging markets need to actually build theirs. As with alternative energy, government stimulus funds can only add to the attraction of this sector.

Largest ETF: The iShares S&P Global Infrastructure Index Fund (NYSE Arca: IGF) is the largest infrastructure ETF available today, with $267 million in assets. See Murray Coleman’s feature on page 6 of this issue for a complete review of the infrastructure ETFs.

Transportation

If oil is the lifeblood of the industrialized world, transportation is the circulatory system. It’s no accident that the world’s (arguably) first stock index was the Dow Jones Transportation Average. And it’s also no surprise that there are a few ETFs focused on transportation.

Largest ETF: The Claymore/Delta Global Shipping ETF (NYSE Arca: SEA) is the largest transportation ETF, with more than $70 million in assets. SEA is sometimes seen as a leading indicator both of economic activity and commodities demand, since rising rates for ships mean incipient increases in industrial production on the receiving end of those shipments.

Green

Not only are there clean energy ETFs, but there are also ETFs that take environmentally friendly approaches in other ways. Two funds and an ETN—the only one in this survey—focus on ecological innovation, such as combating global warming.

Largest ETF: The largest ETF of the bunch is the PowerShares Cleantech Portfolio (NYSE Arca: PZD), which invests in a variety of companies whose products help improve productivity while minimizing the consumption of natural resources. PZD has $123 million in assets.

Miscellaneous

And finally, there’s the “miscellaneous” catch-all category. The funds falling into this category include the only available gaming ETF, a fund covering luxury items and another tracking the Chinese real estate market.

Largest ETF: The largest ETF of the bunch is the Market Vectors Gaming ETF (NYSE Arca: BJK), which invests in gaming (read: gambling) companies around the world. It has roughly $108 million in assets.

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.)

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.

XShares Advisors LLC has announced that it plans to close the AirShares EU Carbon Allowances Fund (NYSE Arca: ASO).

Entering July, the exchange-traded product had just $4 million in assets. ASO launched in December 2008 with nearly $5 million in seed money as an asset base.

ASO is actually a commodity pool that tracks a basket of exchange-traded futures contracts for European Union allowances (EUAs). Each contract provides for delivery of 1,000 EUAs at a specified price.

The ETF-like product, as AirShares refers to ASO, invests in futures contracts that expire each December beginning in 2009 and extending through 2012. As contracts approach their December expiration, the fund sells expiring contracts and replaces them with contracts of later expirations.

Since the commodities involved aren't physically deliverable, ASO can't be considered an ETF. But it acts like many exchange-traded commodities products that are popular in Europe.

Carbon exchange-traded products began appearing in the second half of last year to much hoopla. But their role in a diversified investment portfolio remains in debate since little in the way of research is out on how investing in such a niche corner of the market can impact long-term portfolios.

That has led to speculation that only traders well-versed in carbon emissions markets would trade such futures contracts through an exchange-traded product.

ASO was actually the second such fund of its type. Another type of fund, referred to as an exchange-traded note, was first to market in the carbon field. Last June, Barclays Capital gained first-mover status into the U.S. exchange-traded products market for carbon emissions with its iPath Global Carbon ETN (NYSE Arca: GRN).

Just like ASO, it trades throughout the day along an exchange. But GRN is priced a bit cheaper at 0.75%. As an ETN, however, GRN carries counterparty risk since it actually represents an investment in unsecured debt notes.

Interestingly, GRN isn't doing any better than ASO. It has less than $3 million in total assets.

In announcing the shuttering of ASO, XShares said that it "has considered the current market conditions and the growth prospects of the small fund in the foreseeable future and decided that liquidation was in the best interests of the fund and its shareholders."

The fund is eligible to de-register because it has fewer than 300 common stock shareholders of record.

Shareholders may sell their shares without transaction fees on or before July 31, the firm added in its statement. All shareholders of record remaining on that day will receive cash equivalent to the net asset value of their shares as of the same date, including any capital gains and dividends.

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

Brad Durham is co-founder and managing director at EPFR Global. The Cambridge, Mass.-based research firm tracks global fund flows, both institutional as well as retail for financial institutions. It tracks an estimated $10 trillion in sector, country and asset class flows on a daily, weekly and monthly basis for both fixed income and equities.

Before helping to start EPFR 14 years ago, Durham was editor of publications focused on the economics and politics of emerging markets. That included launching and operating several Russian financial publications, including Kommersant and a joint venture with Hearst Corp. and Izvestia. Durham has earned a doctorate from Suffolk University Law School and a master’s degree in journalism from Boston University.

On Monday, IndexUniverse.com Editor Murray Coleman caught up with the analyst for his views on changes in the landscape of exchange-traded funds around the world.

IndexUniverse: Money has been flowing into ETFs consistently through good times and bad, haven’t they?

Durham: Yes, and we’re seeing a definite increase in activity over the past several months. Since early March, net inflows into bond ETFs have reached about $16 billion. At the same time, equity ETFs have shown about $4.6 billion inflows through July 15. Non-ETFs are a different story, though. We’ve seen some pretty big outflows in mutual funds investing predominately in developed markets and U.S. equities. Those types of open-end mutual funds have lost $2.6 billion in net outflows since March 4. On the other hand, bond mutual funds have produced inflows of $25 billion.

Interestingly, the inflows into bond ETFs amount to about 25% of their assets. That’s a pretty eye-popping number. For example, the iShares Barclays 1-3 Year Credit Bond Index (NYSE:CSJ) has taken in $111.2 million in assets during the past 12 weeks. That’s the second-biggest; the iShares  Barclays TIPS Bond (NYSE: TIP) has attracted $139.9 million in that period.

By contrast, the biggest inflows among equity ETFs has been the SPDR S&P 500 ETF (NYSE: SPY) with $649 million. The next biggest was Energy Select Sector SPDR ETF (NYSE: XLE) with $600.4 million followed by the Vanguard Emerging Markets ETF (NYSE: VWO) with $233.3 million.

IndexUniverse: So emerging markets inflow is still very strong?

Durham: It has definitely been tapering off in the past few weeks. For example, we’ve seen about $29.1 billion in net inflow into all EM market stock funds from the beginning of 2009 through the first week of March. That included  both mutual funds and ETFs. Since then – the first week of March through July 15 – about $28.3 billion has flown into all types of EM stock funds. But a majority of those most recent inflows came at the start of the current rally.

IndexUniverse: How does that breakdown in terms of ETFs?

Durham: Of the $28.3 billion net inflows into EM stock funds since March, some $13.4 billion has gone into EM stock ETFs. And year-to-date, EM ETFs have taken in $14.5 billion. So that’s more confirmation that the bulk of the latest activity took place in early March. But if you look at this year compared to 2008, at least flows into EM stock funds are moving into the same direction – both mutual funds and ETFs are experiencing inflows.

In terms of total assets, EM ETFs have been increasing their market share rather dramatically over the past 18 months. Total assets for all EM stock funds now stand at about $356 billion. Of that total, EM stock ETF assets are currently at around $106 billion. That compares with EM stock ETFs comprising about 16% of the total EM stock fund assets as of February 2008.

IndexUniverse: Is that due to greater trading flexibility of ETFs, or more choices in terms of single country and regional emerging market ETFs?

Durham: You’ve still got plenty of choices in emerging markets with open-end mutual funds. But the ease of investing, greater flexibility and much lower fees are attracting more investors to ETFs. In developed markets, sector asset allocation is considered more significant for driving returns. But in emerging markets, investors tend to take a more top-down approach. In the U.S., it’s pretty well-known that actively managed funds don’t typically outperform index funds. So in emerging markets, where institutions are even more important in driving money flows, the natural inclination is to drive costs down through ETFs.

IndexUniverse: What are you seeing in commodities?

Durham: We had been seeing inflows, but now it’s going in the opposite direction. Commodities funds were the big magnet in the first part of the year.  Those have taken in about $8.2 billion year-to-date through July 15. ETF-only commodity funds have dominated with about $5.3 billion in net inflows. The biggest gainer in 2009 has been the Market Vectors Gold Miners ETF (NYSE: GDX) with $1.2 billion. The next was the iShares S&P GSCI Commodity Indexed Trust (NYSE: GSG) at $860.2 million.

Lately, though, both commodity mutual fund and ETF flows have been slowing. Flows peaked on June 24^th and have lost about $500 million since then. Of that total, about $180 million in net outflows have come from commodity ETFs –- although energy has seen slight inflows during that time.

Brad Durham is co-founder and managing director at EPFR Global. The Cambridge, Mass.-based research firm tracks global fund flows, both institutional as well as retail, for financial institutions. It tracks an estimated $10 trillion in sector, country and asset class flows on a daily, weekly and monthly basis both for fixed income and equities.

Before helping to start EPFR 14 years ago, Durham was editor of publications focused on the economics and politics of emerging markets. That included launching and operating several Russian financial publications, including Kommersant and a joint venture with Hearst Corp. and Izvestia. Durham has earned a doctorate from Suffolk University Law School and a master’s degree in journalism from Boston University.

On Monday, IndexUniverse.com Editor Murray Coleman caught up with the analyst for his views on changes in the landscape of exchange-traded funds around the world.

IndexUniverse: Money has been flowing into ETFs consistently through good times and bad, haven’t they?

Durham: Yes, and we’re seeing a definite increase in activity over the past several months. Since early March, net inflows into bond ETFs have reached about $16 billion. At the same time, equity ETFs have shown about $4.6 billion inflows through July 15. Non-ETFs are a different story, though. We’ve seen some pretty big outflows in mutual funds investing predominantly in developed markets and U.S. equities. Those types of open-end mutual funds have lost $2.6 billion in net outflows since March 4. On the other hand, bond mutual funds have produced inflows of $25 billion.

Interestingly, the inflows into bond ETFs amount to about 25% of their assets. That’s a pretty eye-popping number. For example, the iShares Barclays 1-3 Year Credit Bond Index (NYSE: CSJ) has taken in $111.2 million in assets during the past 12 weeks. That’s the second-biggest; the iShares Barclays TIPS Bond (NYSE: TIP) has attracted $139.9 million in that period.

By contrast, the biggest inflows among equity ETFs has been the SPDR S&P 500 ETF (NYSE: SPY), with $649 million. The next biggest was Energy Select Sector SPDR ETF (NYSE: XLE), with $600.4 million, followed by the Vanguard Emerging Markets ETF (NYSE: VWO), with $233.3 million.

IndexUniverse: So emerging markets inflow is still very strong?

Durham: It has definitely been tapering off in the past few weeks. For example, we’ve seen about $29.1 billion in net inflow into all emerging market stock funds from the beginning of 2009 through the first week of March. That included mutual funds and ETFs. Since then—the first week of March through July 15—about $28.3 billion has flown into all types of emerging market stock funds. But a majority of those most recent inflows came at the start of the current rally.

IndexUniverse: How does that break down in terms of ETFs?

Durham: Of the $28.3 billion net inflows into EM stock funds since March, some $13.4 billion has gone into EM stock ETFs. And year-to-date, EM ETFs have taken in $14.5 billion. So that’s more confirmation that the bulk of the latest activity took place in early March. But if you look at this year compared to 2008, at least flows into EM stock funds are moving into the same direction—both mutual funds and ETFs are experiencing inflows.

In terms of total assets, EM ETFs have been increasing their market share rather dramatically over the past 18 months. Total assets for all EM stock funds now stand at about $356 billion. Of that total, EM stock ETF assets are currently at around $106 billion. That compares with EM stock ETFs comprising about 16% of the total EM stock fund assets as of February 2008.

IndexUniverse: Is that due to greater trading flexibility of ETFs, or more choices in terms of single country and regional emerging market ETFs?

Durham: You’ve still got plenty of choices in emerging markets with open-end mutual funds. But the ease of investing, greater flexibility and much lower fees are attracting more investors to ETFs. In developed markets, sector asset allocation is considered more significant for driving returns. But in emerging markets, investors tend to take a more top-down approach. In the U.S., it’s pretty well known that actively managed funds don’t typically outperform index funds. So in emerging markets, where institutions are even more important in driving money flows, the natural inclination is to drive costs down through ETFs.

IndexUniverse: What are you seeing in commodities?

Durham: We had been seeing inflows, but now it’s going in the opposite direction. Commodities funds were the big magnet in the first part of the year. Those have taken in about $8.2 billion year-to-date through July 15. ETF-only commodity funds have dominated with about $5.3 billion in net inflows. The biggest gainer in 2009 has been the Market Vectors Gold Miners ETF (NYSE: GDX), with $1.2 billion. The next was the iShares S&P GSCI Commodity Indexed Trust (NYSE: GSG), at $860.2 million.

Lately, though, commodity mutual fund and ETF flows have been slowing. Flows peaked on June 24 and have lost about $500 million since then. Of that total, about $180 million in net outflows have come from commodity ETFs—although energy has seen slight inflows during that time.

Bob Holderith is chief executive of Emerging Global Advisors. Richard Kang is chief investment officer for the New York-based company, which recently launched the first exchange-traded funds focused on specific sectors in emerging markets. (See related story here.)

EGA is expected to launch soon a third ETF that will act as a composite of the 10 underlying sectors in the Dow Jones emerging markets indexing series it’s using for current and upcoming funds.

The company says that nine more are in the works focusing on emerging markets sectors. Those will join the May launches of the EGS Emerging Markets Energy Fund (NYSE Arca: EEO) and the  EGS Emerging Markets Metals & Mining Fund (NYSE Arca: EMT).

IndexUniverse.com’s Murray Coleman caught up with Holderith and Kang late Thursday to discuss the future of sector investing in developing markets.

IU: What is available for U.S.-based investors in terms of foreign sector ETFs now?

Holderith: The family of Select Sector SPDRs is the dominant ETF line providing sector-based exposures.  They’ve got a long history. But those ETFs only focus on U.S. companies. For pure international exposure to foreign sectors, we’ve only seen two-  to three- years worth of actual performance history. And that’s through the iShares’ global sector family of funds as well as those of State Street Global Advisors. The SSgA  family is purely international sector ETFs.

IU: Then your firm’s line-up of international sector ETFs will compete most directly against those of SSgA?

Kang: No, since the SSgA ETFs are focused predominately on developed markets. For example, take the SPDR S&P International Financial Sector (NYSE: IPF). The top weighted countries are (in order): Japan, Canada, Australia, the U.K., Spain and Switzerland. The SSgA international sector ETFs do allow for some emerging markets exposure. But as cap-weighted indexes, they’re heavily skewed to developed countries.

IU: Why is your company going with pure emerging markets exposure rather than a mix of developed and emerging markets?

Holderith: There’s more than enough coverage of developed international markets now in the ETF marketplace. In terms of emerging markets, we’ve seen broad, regional and country specific funds. But we’re first to market with sector-specific ETFs for developing countries. The EMT and EEO ETFs are the first of a series we’re preparing to launch.

IU: What others are planned?

Holderith: We’ve got in the pipeline 10 ETFs still left to bring-to-market. Those will all use Dow Jones indexes, similar to those used by EMT and EEO. Dow Jones uses a classification system for sectors called the ICB (or industry classification benchmark) system. The other sector-specific ETFs in various stages of planning we’re working on launching cover: basic materials; consumer goods; consumer services; financials; health care; industrials; technology; telecom and utilities.

IU: You’ve also got a broader ETF that has received regulatory approval, don’t you?

Holderith: Yes, we’ve got a composite ETF that’s due to launch within the next few weeks.  That’s an ETF tracking a Dow Jones index that takes the top 10 names from each of the 10 major emerging markets sectors. (It won’t include metals and mining, which is a subsector of basic materials.)  So that will leave 100 names in the underlying composite index. And as in all of our ETFs, we have a rule that caps individual weightings at no more than 10%.

IU: In the composite index for such an emerging markets fund, what would the sector weightings look like then?

Holderith: Oil and gas along with financials are the dominant sectors in the composite index.

IU: What type of performance have you seen through back-tested data for emerging markets sector indexes compared to developed markets sector indexes?

Kang: We have data going back many years for the underlying benchmarks. The data for emerging markets, however, isn’t as robust as that for developed markets. So we really focus on data going back to December 2005 when comparing the Dow Jones composite benchmark we’re using for our emerging markets sector funds.

IU: What do those comparisons show?

Kang: Going back to 2005, returns were generally spectacular up through 2007 for emerging markets vs. developed markets. In the latter half of 2008, we saw greater volatility and bigger losses in emerging markets. As with any more volatile asset class, emerging markets offers the potential for greater long-term gains as a result. Clearly, some sectors performed better in relative terms during the periods when markets were going up versus others.  The same is true in the bear market of 2008.  That is the essence of the popularity of sector funds -- their selection during different stages of the market cycle.

IU: How correlated are emerging markets sectors to developed markets sectors?

Kang: That’s a tricky question. It depends on your timeframe. In statistical terms, there’s just not a lot of data. But you can draw some general conclusions. There are times, like in the bull market from 2005-2007, when many sectors in emerging markets and developed markets were highly correlated. Commodity stocks were highly correlated during the commodities boon regardless of location. On the other hand during the credit crisis, financials haven’t been as highly correlated because banks in the U.K, for example, have been exposed to more toxic assets than banks in places like China, Brazil and India.

IU: What do you see as the biggest benefits of breaking emerging markets into sectors?

Kang: A lot of investors managing their emerging markets exposures are doing so by allocating between countries. The question we asked at the very beginning of creating our ETFs is how much overlap there is between sectors and geography.

Let’s say you’re an American investor with heavy exposure to the S&P 500 index. Maybe you’ve tilted your  portfolio a little to commodities through funds such as the SPDR Gold Shares (NYSE: GLD) and the iPath Dow Jones-AIG Commodity Index ETN (NYSE: DJP). If you’ve got that portfolio, you look more like a Canadian or an Aussie – both of those countries are heavily influenced by movements in natural resources prices.

IU: In other words, broader-based ETFs don’t add a lot in those situations?

Kang: The inclusion of broad emerging market ETFs as well as many of the country specific ETFs to this kind of portfolio would not provide diversification as correlations would be surprisingly high.  For true diversification, the inclusion of certain sectors would likely provide more optimal risk-return characteristics to the overall portfolio.

Furthermore, many investors who invest in emerging markets country ETFs do so based on a sector-type of rationale. For example, let’s say someone wants to invest in Russia. The question I would ask is: Do you want to invest in that country to be more richly compensated with some sort of political risk associated with that country? Or, are you investing in Russia to make an oil and gas bet? If that’s the case, do you want to put all your eggs in one basket – Russia. Or, would you prefer to invest in a basket focused on oil and gas but with companies from Russia, India, China, Brazil and several others?

IU: Those are the top countries in EEO, aren’t they?

Kang: Yes. Those four countries comprise roughly two-thirds of the fund. And with EMT, the top countries are: South Africa, Brazil, China and Russia. Those take up more than three-quarters of the fund.

Bob Holderith is chief executive of Emerging Global Advisors. Richard Kang is chief investment officer for the New York-based company, which recently launched the first exchange-traded funds focused on specific sectors in emerging markets. (See related story here.)

EGA is expected to launch soon a third ETF that will act as a composite of the 10 underlying sectors in the Dow Jones emerging markets indexing series it’s using for current and upcoming funds.

The company says that nine more are in the works focusing on emerging markets sectors. Those will join the May launches of the EGS Emerging Markets Energy Fund (NYSE Arca: EEO) and the  EGS Emerging Markets Metals & Mining Fund (NYSE Arca: EMT).

IndexUniverse.com’s Murray Coleman caught up with Holderith and Kang late Thursday to discuss the future of sector investing in developing markets.

IU: What is available for U.S.-based investors in terms of foreign sector ETFs now?

Holderith: The family of Select Sector SPDRs is the dominant ETF line providing sector-based exposures.  They’ve got a long history. But those ETFs only focus on U.S. companies. For pure international exposure to foreign sectors, we’ve only seen two-  to three- years worth of actual performance history. And that’s through the iShares’ global sector family of funds as well as those of State Street Global Advisors. The SSgA  family is purely international sector ETFs.

IU: Then your firm’s line-up of international sector ETFs will compete most directly against those of SSgA?

Kang: No, since the SSgA ETFs are focused predominately on developed markets. For example, take the SPDR S&P International Financial Sector (NYSE: IPF). The top weighted countries are (in order): Japan, Canada, Australia, the U.K., Spain and Switzerland. The SSgA international sector ETFs do allow for some emerging markets exposure. But as cap-weighted indexes, they’re heavily skewed to developed countries.

IU: Why is your company going with pure emerging markets exposure rather than a mix of developed and emerging markets?

Holderith: There’s more than enough coverage of developed international markets now in the ETF marketplace. In terms of emerging markets, we’ve seen broad, regional and country specific funds. But we’re first to market with sector-specific ETFs for developing countries. The EMT and EEO ETFs are the first of a series we’re preparing to launch.

IU: What others are planned?

Holderith: We’ve got in the pipeline 10 ETFs still left to bring-to-market. Those will all use Dow Jones indexes, similar to those used by EMT and EEO. Dow Jones uses a classification system for sectors called the ICB (or industry classification benchmark) system. The other sector-specific ETFs in various stages of planning we’re working on launching cover: basic materials; consumer goods; consumer services; financials; health care; industrials; technology; telecom and utilities.

IU: You’ve also got a broader ETF that has received regulatory approval, don’t you?

Holderith: Yes, we’ve got a composite ETF that’s due to launch within the next few weeks.  That’s an ETF tracking a Dow Jones index that takes the top 10 names from each of the 10 major emerging markets sectors. (It won’t include metals and mining, which is a subsector of basic materials.)  So that will leave 100 names in the underlying composite index. And as in all of our ETFs, we have a rule that caps individual weightings at no more than 10%.

IU: In the composite index for such an emerging markets fund, what would the sector weightings look like then?

Holderith: Oil and gas along with financials are the dominant sectors in the composite index.

IU: What type of performance have you seen through back-tested data for emerging markets sector indexes compared to developed markets sector indexes?

Kang: We have data going back many years for the underlying benchmarks. The data for emerging markets, however, isn’t as robust as that for developed markets. So we really focus on data going back to December 2005 when comparing the Dow Jones composite benchmark we’re using for our emerging markets sector funds.

IU: What do those comparisons show?

Kang: Going back to 2005, returns were generally spectacular up through 2007 for emerging markets vs. developed markets. In the latter half of 2008, we saw greater volatility and bigger losses in emerging markets. As with any more volatile asset class, emerging markets offers the potential for greater long-term gains as a result. Clearly, some sectors performed better in relative terms during the periods when markets were going up versus others.  The same is true in the bear market of 2008.  That is the essence of the popularity of sector funds -- their selection during different stages of the market cycle.

IU: How correlated are emerging markets sectors to developed markets sectors?

Kang: That’s a tricky question. It depends on your timeframe. In statistical terms, there’s just not a lot of data. But you can draw some general conclusions. There are times, like in the bull market from 2005-2007, when many sectors in emerging markets and developed markets were highly correlated. Commodity stocks were highly correlated during the commodities boon regardless of location. On the other hand during the credit crisis, financials haven’t been as highly correlated because banks in the U.K, for example, have been exposed to more toxic assets than banks in places like China, Brazil and India.

IU: What do you see as the biggest benefits of breaking emerging markets into sectors?

Kang: A lot of investors managing their emerging markets exposures are doing so by allocating between countries. The question we asked at the very beginning of creating our ETFs is how much overlap there is between sectors and geography.

Let’s say you’re an American investor with heavy exposure to the S&P 500 index. Maybe you’ve tilted your  portfolio a little to commodities through funds such as the SPDR Gold Shares (NYSE: GLD) and the iPath Dow Jones-AIG Commodity Index ETN (NYSE: DJP). If you’ve got that portfolio, you look more like a Canadian or an Aussie – both of those countries are heavily influenced by movements in natural resources prices.

IU: In other words, broader-based ETFs don’t add a lot in those situations?

Kang: The inclusion of broad emerging market ETFs as well as many of the country specific ETFs to this kind of portfolio would not provide diversification as correlations would be surprisingly high.  For true diversification, the inclusion of certain sectors would likely provide more optimal risk-return characteristics to the overall portfolio.

Furthermore, many investors who invest in emerging markets country ETFs do so based on a sector-type of rationale. For example, let’s say someone wants to invest in Russia. The question I would ask is: Do you want to invest in that country to be more richly compensated with some sort of political risk associated with that country? Or, are you investing in Russia to make an oil and gas bet? If that’s the case, do you want to put all your eggs in one basket – Russia. Or, would you prefer to invest in a basket focused on oil and gas but with companies from Russia, India, China, Brazil and several others?

IU: Those are the top countries in EEO, aren’t they?

Kang: Yes. Those four countries comprise roughly two-thirds of the fund. And with EMT, the top countries are: South Africa, Brazil, China and Russia. Those take up more than three-quarters of the fund.

Bob Holderith is chief executive of Emerging Global Advisors. Richard Kang is chief investment officer for the New York-based company, which recently launched the first exchange-traded funds focused on specific sectors in emerging markets. (See related story here.)

EGA is expected to launch soon a third ETF that will act as a composite of the 10 underlying sectors in the Dow Jones emerging markets indexing series it’s using for current and upcoming funds.

The company says that nine more are in the works focusing on emerging markets sectors. Those will join the May launches of the EGS Emerging Markets Energy Fund (NYSE Arca: EEO) and the EGS Emerging Markets Metals & Mining Fund (NYSE Arca: EMT).

IndexUniverse.com’s Murray Coleman caught up with Holderith and Kang late Thursday to discuss the future of sector investing in developing markets.

IU: What is available for U.S.-based investors in terms of foreign sector ETFs now?

Holderith: The family of Select Sector SPDRs is the dominant ETF line providing sector-based exposures. They’ve got a long history. But those ETFs only focus on U.S. companies. For pure international exposure to foreign sectors, we’ve only seen two- to three- years worth of actual performance history. And that’s through the iShares’ global sector family of funds as well as those of State Street Global Advisors. The SSgA family is purely international sector ETFs.

IU: Then your firm’s line-up of international sector ETFs will compete most directly against those of SSgA?

Kang: No, since the SSgA ETFs are focused predominately on developed markets. For example, take the SPDR S&P International Financial Sector (NYSE: IPF). The top weighted countries are (in order): Japan, Canada, Australia, the U.K., Spain and Switzerland. The SSgA international sector ETFs do allow for some emerging markets exposure. But as cap-weighted indexes, they’re heavily skewed to developed countries.

IU: Why is your company going with pure emerging markets exposure rather than a mix of developed and emerging markets?

Holderith: There’s more than enough coverage of developed international markets now in the ETF marketplace. In terms of emerging markets, we’ve seen broad, regional and country specific funds. But we’re first to market with sector-specific ETFs for developing countries. The EMT and EEO ETFs are the first of a series we’re preparing to launch.

IU: What others are planned?

Holderith: We’ve got in the pipeline 10 ETFs still left to bring-to-market. Those will all use Dow Jones indexes, similar to those used by EMT and EEO. Dow Jones uses a classification system for sectors called the ICB (or industry classification benchmark) system. The other sector-specific ETFs in various stages of planning we’re working on launching cover: basic materials; consumer goods; consumer services; financials; health care; industrials; technology; telecom and utilities.

IU: You’ve also got a broader ETF that has received regulatory approval, don’t you?

Holderith: Yes, we’ve got a composite ETF that’s due to launch within the next few weeks. That’s an ETF tracking a Dow Jones index that takes the top 10 names from each of the 10 major emerging markets sectors. (It won’t include metals and mining, which is a subsector of basic materials.) So that will leave 100 names in the underlying composite index. And as in all of our ETFs, we have a rule that caps individual weightings at no more than 10%.

IU: In the composite index for such an emerging markets fund, what would the sector weightings look like then?

Holderith: Oil and gas along with financials are the dominant sectors in the composite index.

IU: What type of performance have you seen through back-tested data for emerging markets sector indexes compared to developed markets sector indexes?

Kang: We have data going back many years for the underlying benchmarks. The data for emerging markets, however, isn’t as robust as that for developed markets. So we really focus on data going back to December 2005 when comparing the Dow Jones composite benchmark we’re using for our emerging markets sector funds.

IU: What do those comparisons show?

Kang: Going back to 2005, returns were generally spectacular up through 2007 for emerging markets vs. developed markets. In the latter half of 2008, we saw greater volatility and bigger losses in emerging markets. As with any more volatile asset class, emerging markets offers the potential for greater long-term gains as a result. Clearly, some sectors performed better in relative terms during the periods when markets were going up versus others. The same is true in the bear market of 2008. That is the essence of the popularity of sector funds -- their selection during different stages of the market cycle.

IU: How correlated are emerging markets sectors to developed markets sectors?

Kang: That’s a tricky question. It depends on your timeframe. In statistical terms, there’s just not a lot of data. But you can draw some general conclusions. There are times, like in the bull market from 2005-2007, when many sectors in emerging markets and developed markets were highly correlated. Commodity stocks were highly correlated during the commodities boon regardless of location. On the other hand during the credit crisis, financials haven’t been as highly correlated because banks in the U.K, for example, have been exposed to more toxic assets than banks in places like China, Brazil and India.

IU: What do you see as the biggest benefits of breaking emerging markets into sectors?

Kang: A lot of investors managing their emerging markets exposures are doing so by allocating between countries. The question we asked at the very beginning of creating our ETFs is how much overlap there is between sectors and geography.

Let’s say you’re an American investor with heavy exposure to the S&P 500 index. Maybe you’ve tilted your portfolio a little to commodities through funds such as the SPDR Gold Shares (NYSE: GLD) and the iPath Dow Jones-AIG Commodity Index ETN (NYSE: DJP). If you’ve got that portfolio, you look more like a Canadian or an Aussie – both of those countries are heavily influenced by movements in natural resources prices.

IU: In other words, broader-based ETFs don’t add a lot in those situations?

Kang: The inclusion of broad emerging market ETFs as well as many of the country specific ETFs to this kind of portfolio would not provide diversification as correlations would be surprisingly high. For true diversification, the inclusion of certain sectors would likely provide more optimal risk-return characteristics to the overall portfolio.

Furthermore, many investors who invest in emerging markets country ETFs do so based on a sector-type of rationale. For example, let’s say someone wants to invest in Russia. The question I would ask is: Do you want to invest in that country to be more richly compensated with some sort of political risk associated with that country? Or, are you investing in Russia to make an oil and gas bet? If that’s the case, do you want to put all your eggs in one basket – Russia. Or, would you prefer to invest in a basket focused on oil and gas but with companies from Russia, India, China, Brazil and several others?

IU: Those are the top countries in EEO, aren’t they?

Kang: Yes. Those four countries comprise roughly two-thirds of the fund. And with EMT, the top countries are: South Africa, Brazil, China and Russia. Those take up more than three-quarters of the fund.

The world's more recognized investable blue-chip index could be getting triple-leverage coverage for the first time.

ProShares has filed to launch an exchange-traded fund seeking to provide 300% of the daily returns of the S&P 500 index. It's also requesting approval from the Securities and Exchange Commission for a new ETF that would give investors 300% short exposure of the index.

Both would have expense ratios of 0.95% and trade on the NYSE exchange. Earlier this year, ProShares filed to offer 3X leverage with 94 new ETFs. But in that April filing, no mention was made of the S&P 500. (See related story here.)

Currently, ProShares offers the Ultra S&P 500 ETF (NYSE: SSO). But that provides 200%, or 2X, the daily returns of its benchmark. It also has the UltraShort S&P 500 ETF (NYSE: SDS), which again shoots for a 200% return—except on the inverse side.

Rival Direxion already has a pair of large-cap domestic-focused ETFs with 300% leveraged and inverse exposure. Those are the Daily Large Cap Bull 3x Shares (NYSE: BGU) and the Daily Large Cap Bear 3x Shares (NYSE: BGZ). The difference is that those both track the Russell 1000, a bit broader index than the S&P 500.

But both have performed in a very similar fashion over the longer term, although some slight differences have shown up at times. The SPDRs S&P 500 ETF (NYSE: SPY), for example, had returned in the past five years heading into Wednesday an average annualized -3%. By comparison, the iShares Russell 1000 (NYSE: IWB) was down 2.56% in that same period.

So far this year, SPY is slightly down this year, while IWB has gained more than 1.3%.

More to the point for anyone interested in the ProShares 3X filings, the bullish Direxion BGU has lost more than 14% so far this year, while the bearish has dropped more than 33%.

But as many investors have learned the hard way since they came onto the market last year, 3X leveraged and inverse ETFs don't always march in lockstep with their underlying benchmarks' daily returns.

The subject has been a sore point for many in the industry. (See our latest look at the situation in the blog "What's Wrong With ETFs.")

You can read the prospectuses for both proposed 3X ProShares funds here.

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

Mike Bayer considers himself a contrarian investor.

In the past few months, as stock markets soared, that sort of go-against-the-grain approach has taken center stage.

The Toronto, Canada-based adviser and president of Strategic Analysis Capital Management says he prefers to buy exchange-traded funds and mutual funds from Dimensional Fund Advisors when they’re out of favor.

“The problem most investors have is that they tend to trade too frequently and make changes in the wrong direction. They’re buying high and selling low,” said Bayer, who works with individual and institutional clients in Canada and the United States.

Since early March, SACM has been taking advantage of the rally in stocks to rebalance client portfolios. Bayer has been trimming positions in the Vanguard Emerging Markets Stock ETF (NYSE: VWO).

“Emerging markets have had a big run-up in the past few months,” he said. “I’ve been carefully monitoring portfolios to make sure they stay within our asset allocation limits. In cases where VWO has exceeded those bands, we’ve sold positions and redeployed proceeds into mainly bond funds.”

The proceeds from selling VWO have been mainly going into buying more fixed-income ETFs and funds, says Bayer. Those include the iShares Barclays TIPS Bond ETF (NYSE: TIP) and the iShares Barclays 1-3 Year Credit Bond ETF (NYSE: CSJ). The firm has also been adding to positions in the DFA Five-Year Global Fixed-Income Fund (DFGBX).

Typically with fixed-income portfolios, Bayer will allocate about a third to DFGBX, another third to CSJ and the remainder in TIP.

“Usually, we’ll use a band of about 5% to determine when to make changes,” he said. “But that’s not a hard-and-fast rule. If someone’s in a taxable account, we’ll customize our rebalancing strategies so people can take advantage of tax-loss harvesting and reduce their overall tax liabilities.”

Taking A Cue From History

Bayer says he’s a big fan of simplicity in investing. He likes to stick with four to seven funds built around the long-term needs of each client. “The portfolios are built around broad diversification, but they don’t include commodities,” he added. “That asset class tends to add too much volatility. And over time, it doesn’t necessarily add any additional return.”

In a typical portfolio with 60% equities and 40% bonds, Bayer likes to keep around 45% of total stock assets in funds focused on the U.S. and Canada.

With a total stock market approach, he’ll use the Vanguard Total Stock Market ETF (NYSE: VTI) or the Vanguard Total World Stock ETF (NYSE: VT). In cases where VTI is implemented, at least 60% will go into that fund. Bayer also uses as core holdings the DFA U.S. Core Equity 1 (DFEOX) and the DFA U.S. Vector Equity Fund (DFVEX).

But with clients who don’t mind being a bit more aggressive, Bayer prefers to slice and dice allocations. He’ll put an equal percentage of U.S. stock allocations into the four corners of the market: large-cap value, large-cap blend as well as small-cap value and small-cap blend.

In a slice-and-dice portfolio, Bayer uses the iShares Russell 1000 Value Index (NYSE: IWD) and the Vanguard Value ETF (NYSE: VTV). He balances those with the iShares Russell 1000 (NYSE: IWB) or the Vanguard Total Stock Market ETF (NYSE: VTI).

“If you have a long time horizon and can handle the volatility, slicing and dicing the market can really provide some extra benefits,” said Bayer. “But a slice-and-dice strategy isn’t necessarily the easiest type of portfolio to hold. You need to remain very disciplined to make it work well over time.”

Nod To Small-Cap Value

Even with a more total-markets approach, the firm still likes to tilt allocations toward small-caps and value. On the small-cap side, it uses the iShares Russell 2000 Value Index (NYSE Arca: IWN) and the Vanguard Small Cap Value ETF (NYSE: VBR).

Whether slicing and dicing or total markets in design, Bayer says his portfolios avoid small-cap growth. “It just adds a lot of unneeded volatility and lower returns over time,” he said. “I’m a value investor. So even when a client is better-suited to a more total markets approach, I still like to tilt towards value.”

In those cases, he will add blended ETFs such as the iShares Russell 2000 Index (NYSE Arca: IWM) and the Vanguard Small Cap ETF (NYSE: VB).

“Usually, I’ll start by talking to clients about taking a total stock market fund and then adding IWN or VBR to tilt the portfolio a bit,” said Bayer. “Taking a total market approach appeals to a lot of people in terms of simplicity and slightly lower costs.”

A Global View Of Markets

In a global portfolio, Bayer leans toward about 55% in non-U.S. stocks. “I’m not trying to predict whether foreign markets are doing better than the U.S.,” he said. “But a 55% international tilt roughly follows the global market capitalization percentages of VT, which is a good barometer of the total world market.”

For international exposure, he’ll buy the iShares MSCI EAFE Index (NYSE: EFA) or the Vanguard Europe Pacific ETF (NYSE: VEA). Bayer also uses the Vanguard FTSE All-World ex-US ETF (NYSE: VEU) for some investors. In a standard portfolio, he’ll put about 10-15% into emerging markets of the stock portion of his global portfolios.

For international, Bayer also talks to clients about the DFA International Core Equity Fund (DFIEX) and the DFA Emerging Marktes Core Fund (DFVQX).

“In the U.S., DFA separates developed and emerging markets,” he added. “So if we use one of those funds, we’ll also include a dedicated emerging markets fund. In those cases, we like the DFA International Vector Equity Fund (DFCEX).”

His bent toward sticking with broad-based asset classes and a disciplined strategic allocation approach to investing has its roots in the tech boom. Bayer was managing accounts for a large technology distributor and watched investors rush into hot sectors and get crushed from 2000-2002.

“I’ve always been an index investor. But back then, there weren’t as many choices with ETFs, especially to gain international exposure. But I was an early adopter,” said Bayer, who began investing for himself as well as family and friends as a teenager.

He decided to work with individual investors in 2002 and joined a small local brokerage. “They were selling traditional high-fee mutual funds,” said Bayer. “My strong preference was to use ETFs and DFA funds, which are lower-costing and provide superior long-term risk-adjusted performance,” he said.

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

Larry Swedroe is a principal and director of research for St. Louis-based Buckingham Asset Management. He has authored or co-authored seven books. Before joining Buckingham in 1996, he was a senior vice president at Citicorp and vice chairman of Residential Service Corp.

On Monday, IndexUniverse.com Managing Editor Murray Coleman caught up with Swedroe to discuss the plight of bonds and buy-and-hold investing, among other issues. (It should be noted that he and another Buckingham colleague, Joe Hempen, co-authored a book on bond investing in 2006.)

IndexUniverse: Did you recently suggest a portfolio of largely municipal bonds for investors?

Swedroe: That was a reference someone took from an example I was using concerning my own portfolio. I definitely wasn’t making a recommendation for everyone to use. There is no "right" asset allocation—or portfolio—for everyone. All of these cookie-cutter solutions people throw out are garbage. They’ve got about as much chance of being right as buying a lottery ticket.

It is important to note that my low-equity allocation does not reflect a negative view on stock returns. Instead, it reflects my own situation and that is that I have reached a point where my own marginal utility of wealth is very low. Therefore, I have little need to take risk.

IndexUniverse: What do you think about suggestions that bonds are now positioned as a less-risky asset class than equities over the long term?

Swedroe: People have recently conducted studies looking back at different longer-term periods and concluded that stocks aren’t likely to outperform bonds going forward. In my view, that’s nothing more than beta-mining. It’s just absolute trash.

IndexUniverse: Why is that?

Swedroe: Let’s start with Jeremy Siegel’s book, “Stocks For The Long Run.” It was a very dangerous book if people took the wrong message away, which many did. The book implied to some investors that stocks aren’t risky if your investment horizon is long enough. I don’t think that Siegel was trying to claim that as a fact. But clearly, that’s the message many people took out of that book.

If there’s no risk, then the expected returns of stocks over any extended period would be about the same as bonds. That’s insanity. Stocks have returned roughly 10% a year over the past 80 years. The average price-earnings ratio has been roughly 15. If people thought there were no risks in stocks, then the PE would be much higher. If the expected return over 40 years for stocks and Treasuries were the same, which would you buy? It’s just irrational to think that stocks and bonds over the longer term have the same risk profiles.

IndexUniverse: So such arguments about the outperformance of bonds are simply data mining?

Swedroe: What they were doing is going back to a period when bond yields were significantly higher and stock returns were significantly lower. From 1969 through 2008, both the S&P 500 and 20-year government bonds both earned 9% exactly. (And that's assuming someone would go back and repurchase the same types of 20-year government bonds as they expired.) We started that period with high stock prices and ended with stock prices at low levels.

On the other hand, you started that period with high bond yields and ended it with low bond yields. The 20-year bond at the end of 2008 was 3.05%. That meant the expected return over the next 20 years was about 3.05%. Do you think that stocks are going to give you a nominal return of less than 3% over the next 20 years? It can definitely happen. From the years of 1929-1948, stocks averaged a nominal return of 3.1%. That included the years of the Great Depression. But that period started with high stock prices. We’re starting this next period with relatively low PEs and low stock prices.

IndexUniverse: Do you think that the stock market is overbought right now?

Swedroe: Generally, I think the stock market is the best estimate of the right price. But we do know that high PEs predict low future returns. For example, when PEs were over 22, for the next 10 years stock returns were around 5%. On the other hand, when PEs were less than 10, stocks returned about 17%. When the PE was roughly between its average of 14-16, then stocks returned about 10%—their long-term average.

IndexUniverse: Where are PEs now?

Swedroe: Let’s look at the Vanguard Total Stock Market Index Fund (VTSMX). Its trailing PE is at around 12 right now. Then, let’s look at the Vanguard Total International Stock Index Fund (VGTSX), which is at 10.6. And Vanguard’s Emerging Markets Index (VEIEX), which is up almost 40% this year, is virtually the same. So stock PEs are below their long-term averages. That means stocks’ expected returns should be above their long-term averages. The equity risk premium is now greater than their long-term averages.

IndexUniverse: Is buy-and-hold investing dead?

Swedroe: Of course not. Buy-and-hold doesn’t mean you shouldn’t do anything at all, though. You need to buy, hold and rebalance. You’ve got to adhere to an investment plan. And that, by definition, means rebalancing it to adjust to the way markets flow. All along the way, you need to rebalance your portfolio. But time-based rebalancing doesn’t make any sense. You should do risk-based rebalancing. You set a band around each asset class.

IndexUniverse: What are your general thoughts about how people should rebalance their portfolios?

Swedroe: Each person has their own requirements. But any time you have new cash, you should rebalance. And people should remember that since time and costs are real considerations, you want to let your portfolio drift a little. But generally, I like to take a 5/25 approach. That means if an asset class has moved an absolute 5% or a relative 25%, you should probably rebalance.

IndexUniverse: How does that work?

Swedroe: You want to do a rebalancing test at three broad levels. The first is stocks vs. bonds. The second is domestic vs. international stock and then, thirdly, you’ve got to check by size and style as well as separate asset classes on the stock side. That applies to bonds, as well.

IndexUniverse: Can you provide an example of how that would work?

Swedroe: On the individual level, say you only want 4% in commodities. So I’d take 25% of 4%, which is 1%, and I’d rebalance once it goes beyond a 1% move—meaning below 3% or above 5%. But if you’ve got short-term capital gains taxes involved, then I’d wait to rebalance until you’d be triggering long-term capital gains. Or, you can use new money when it’s available to buy more of the under-performers.

Larry Swedroe is a principal and director of research for St. Louis-based Buckingham Asset Management. He has authored or co-authored seven books. Before joining Buckingham in 1996, he was a senior vice president at Citicorp and vice chairman of Residential Service Corp.

On Monday, IndexUniverse.com Managing Editor Murray Coleman caught up with Swedroe to discuss the plight of bonds and buy-and-hold investing, among other issues. (It should be noted that he and another Buckingham colleague, Joe Hempen, co-authored a book on bond investing in 2006.)

IndexUniverse: Did you recently suggest a portfolio of largely municipal bonds for investors?

Swedroe: That was a reference someone took from an example I was using concerning my own portfolio. I definitely wasn’t making a recommendation for everyone to use. There is no "right" asset allocation—or portfolio—for everyone. All of these cookie-cutter solutions people throw out are garbage. They’ve got about as much chance of being right as buying a lottery ticket.

It is important to note that my low-equity allocation does not reflect a negative view on stock returns. Instead, it reflects my own situation and that is that I have reached a point where my own marginal utility of wealth is very low. Therefore, I have little need to take risk.

IndexUniverse: What do you think about suggestions that bonds are now positioned as a less-risky asset class than equities over the long term?

Swedroe: People have recently conducted studies looking back at different longer-term periods and concluded that stocks aren’t likely to outperform bonds going forward. In my view, that’s nothing more than data-mining. It’s just absolute trash.

IndexUniverse: Why is that?

Swedroe: Let’s start with Jeremy Siegel’s book, “Stocks For The Long Run.” It was a very dangerous book if people took the wrong message away, which many did. The book implied to some investors that stocks aren’t risky if your investment horizon is long enough. I don’t think that Siegel was trying to claim that as a fact. But clearly, that’s the message many people took out of that book.

If there’s no risk, then the expected returns of stocks over any extended period would be about the same as bonds. That’s insanity. Stocks have returned roughly 10% a year over the past 80 years. The average price-earnings ratio has been roughly 15. If people thought there were no risks in stocks, then the PE would be much higher. If the expected return over 40 years for stocks and Treasuries were the same, which would you buy? It’s just irrational to think that stocks and bonds over the longer term have the same risk profiles.

IndexUniverse: So such arguments about the outperformance of bonds are simply data mining?

Swedroe: What they were doing is going back to a period when bond yields were significantly higher and stock returns were also significantly higher. From 1969 through 2008, both the S&P 500 and 20-year government bonds both earned 9% exactly. (And that's assuming someone would maintain a constant maturity of 20 years.) We started that period with high stock prices and ended with stock prices at low levels.

On the other hand, you started that period with high bond yields and ended it with low bond yields. The 20-year bond at the end of 2008 was 3.05%. That meant the expected return over the next 20 years was 3.05%. Do you think that stocks are going to give you a nominal return of less than 3% over the next 20 years? It can definitely happen. From the years of 1929-1948, stocks averaged a nominal return of 3.1%. That included the years of the Great Depression. But that period started with high stock prices. We’re starting this next period with relatively low PEs and low stock prices.

IndexUniverse: Do you think that the stock market is overbought right now?

Swedroe: Generally, I think the stock market is the best estimate of the right price. But we do know that high PEs predict low future returns. For example, when PEs were over 22, for the next 10 years stock returns were around 5%. On the other hand, when PEs were less than 10, stocks returned about 17%. When the PE was roughly between its average of 14-16, then stocks returned about 10%—their long-term average.

IndexUniverse: Where are PEs now?

Swedroe: Let’s look at the Vanguard Total Stock Market Index Fund (VTSMX). Its trailing PE is at around 12 right now. Then, let’s look at the Vanguard Total International Stock Index Fund (VGTSX), which is at 10.6. And Vanguard’s Emerging Markets Index (VEIEX), which is up almost 40% this year, is virtually the same. So stock PEs are below their long-term averages. That means stocks’ expected returns should be above their long-term averages. The equity risk premium is now greater than their long-term averages.

IndexUniverse: Is buy-and-hold investing dead?

Swedroe: Of course not. Buy-and-hold doesn’t mean you shouldn’t do anything at all, though. You need to buy, hold and rebalance. You’ve got to adhere to an investment plan. And that, by definition, means rebalancing it to adjust to the way markets flow. All along the way, you need to rebalance your portfolio. But time-based rebalancing doesn’t make any sense. You should do risk-based rebalancing. You set a band around each asset class.

IndexUniverse: What are your general thoughts about how people should rebalance their portfolios?

Swedroe: Each person has their own requirements. But any time you have new cash, you should rebalance. And people should remember that since time and costs are real considerations, you want to let your portfolio drift a little. But generally, I like to take a 5/25 approach. That means if an asset class has moved an absolute 5% or a relative 25%, you should probably rebalance.

IndexUniverse: How does that work?

Swedroe: You want to do a rebalancing test at three broad levels. The first is stocks vs. bonds. The second is domestic vs. international stock and then, thirdly, you’ve got to check by size and style as well as separate asset classes on the stock side. That applies to bonds, as well.

IndexUniverse: Can you provide an example of how that would work?

Swedroe: On the individual level, say you only want 4% in commodities. So I’d take 25% of 4%, which is 1%, and I’d rebalance once it goes beyond a 1% move—meaning below 3% or above 5%. But if you’ve got short-term capital gains taxes involved, then I’d wait to rebalance until you’d be triggering long-term capital gains. Or, you can use new money when it’s available to buy more of the under-performers.

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.

Roger Nusbaum says he isn’t convinced that the current three-month-old stock rally is more than a brief respite from a longer-term secular bear market.

But that isn’t stopping the portfolio manager at Phoenix-based Your Source Financial from seizing opportunities when they present themselves. Nusbaum last week increased his clients’ exposure to the iShares Dow Jones U.S. Technology ETF (NYSE: IYW).

His client portfolios still generally have around 20% in cash. At one point last fall, that was up to 25% in cash. It was the largest amount on a percentage basis that Nusbaum has ever held out of circulation, he says.

“I’m skeptical for a whole host of reasons that a new cyclical bull market has started,” said Nusbaum. “The extent to which the Fed and Treasury have printed money, issued debt and are monetizing some of that debt makes for a very unattractive proposition.”

Also, he sees another enormous wave of repossessions coming. “That’s very scary,” said Nusbaum, who points to recent research by economist and fund manager John Hussman as evidence.

Playing For The Long Term

Despite his own rather stark short-term views, Nusbaum says he feels it’s important to stick to the facts when investing. For him, that means using all sorts of different fundamental factors to evaluate where markets are in any given economic cycle.

He also incorporates a broad technical indicator into his investing toolbox. Nusbaum watches where prices are at any given time for the S&P 500 relative to its 200-day moving average. When the blue chip benchmark is above that level, as it is now, he notes that market conditions are generally positive.

“Despite my concern over market fundamentals going forward, I’m sticking with a disciplined approach,” said Nusbaum. “Instead of trying to guess when markets will turn, I listen to what the market is telling me. And right now, the 200-day moving average on the S&P is indicating that demand is becoming healthier.”

So he’s lightening up on his cash positions in corners of the market that look most appealing to him. One of those is tech, which Nusbaum has been underweighting for quite awhile. “Tech usually has more volatility than the broader market,” he said. “So increasing our weightings there slightly actually will allow our clients to get more bang for their buck as markets turn around.”

Nusbaum added: “This current rally may be a head fake. But even by moving a bit more into tech, we’ve still got about a three-quarter weight [under] the S&P 500.”

And by moving from an extreme underweight to a slight underweight position, he says, “allows me to keep more in cash with the rest of the portfolio in case I’m wrong about a turnaround in the market.”

The point of such a move, says Nusbaum, is to remain flexible enough to retain long-term risk-reward profiles for his client portfolios and not resort to trying to outguess the market.

Taking A Top-Down Approach

Nusbaum starts by carving up the S&P 500. He underweights or equal-weights the 10 major sectors in the index. Those decisions are based on where he perceives markets are in terms of economic cycles and other geopolitical factors in the world.

“I believe in taking a top-down strategy. And the most important decision in that process is when to be in the market and when to be out of the market. For that decision, I rely on the 200-day moving average for the S&P 500,” said Nusbaum.

He then drills into each sector once an overall investment theme is formulated. For example, despite the recent comeback by financials, Nusbaum says he can’t build a very strong fundamental case for owning many banks. “So I own only individual stocks right now in financials. It’s a situation where unless you’re looking to make short-term trades, financial ETFs are just too broad right now,” he said.

Nusbaum has slight overweights in telecom, utilities and materials. He’s using funds such as the Vanguard Telecom Services ETF (NYSE: VOX), the iShares S&P Global Utilities Index (NYSE: JXI) and the iShares S&P Global Materials Index (NYSE: MXI) for part of those exposures. With commodities, his target weight is 4-5%. He’s using the SPDR Gold Shares (NYSE: GLD) and the PowerShares DB Agriculture ETF (NYSE: DBA) to cover that corner of the market.

“Over time, I can see inching our commodities exposure up an additional 2%. But in the near term, I have no plans to do so,” said Nusbaum. “And that’s not a technical decision, it’s a purely fundamental one.”

Despite the tremendous run by commodities in this decade, he says that equities still present the most potential for outperformance over the longer term. “Every 30-40 years, we have decades like this where equities really do poorly relative to other asset classes,” said Nusbaum. “We’ll probably run into another down period in 30-40 years.”

He believes that the U.S. economy is most of the way through its recovery process following the bear market that lasted from mid-2007 up to this March. “If we’re most of the way through the worst of the downturn, a long-term plan of owning a lot of commodities doesn’t make a whole lot of sense,” said Nusbaum.

He expects inflation to heat up, but not necessarily to hyper-levels as some pundits are suggesting. His own belief is that the U.S. will see prices rise on average of around 5-6% on an annualized basis in coming years.

“Although inflation might become more uncomfortable in the future, we’re not at the point where people need to worry. It’s likely that inflation rates will become a little uncomfortable – but not in the hyperinflation range,” said Nusbaum.

In addition to being underweight equities, he’s also underweight fixed income. Nusbaum believes prices on Treasuries are too high right now. “We don’t try to trade fixed income for capital gains. We try to use it to offset portfolio volatility. With that type of an approach, it makes sense for us to wait until prices come down,” said Nusbaum.

He’s also underweighting corporate issues. “Despite the bounce-back by stocks, the fixed-income market is still broken. So I’m not willing to make big bets on corporate issues in order to gain higher yields at this point,” said Nusbaum.

-- 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.

In May, one of the broadest commodities indexes—the S&P GSCI—produced its biggest one-month gain since Iraq invaded Kuwait in September 1990.

The S&P GSCI increased 19.67% in the month. That compared to a gain of 22.94% in September 1990, according to Standard & Poor's, which released the results on Tuesday. (See table below.)

"Solid commodity gains in May were attributed to most commodities accelerating the recovery process from the sharp declines experienced during the second half of 2008 and first quarter of 2009," said Michael McGlone, S&P's director of commodity indexing in a statement.

Year-to-date through May, the S&P GSCI had registered a total return of 5.95%, led by strength in the energy and agriculture sectors.

Sparked by price increases in unleaded gas and crude oil, the S&P GSCI Energy Index increased 25.44% on the month for a year-to-date gain through May of 4.38%. The S&P GSCI Agriculture Index was the second-best-sector performer last month, increasing 12.37% for a year-to-date gain of 8.18% heading into June.

Metals also performed well in May. The S&P GSCI Precious Metals Index gained 11.41%, putting it up 12.71% for the year. The S&P GSCI Industrial Metals Index increased a more modest 5.82% on the month. But it has been the strongest year-to-date sector performer with a gain of 22.23% (led by a 55.72% increase in copper) through May.

--- This article was submitted by IndexUniverse's Murray Coleman.

Manager known for its family of active mutual funds also uses ETFs and index funds in its model portfolios for advisers and private accounts.

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During the past few months, managers at Litman/Gregory Asset Management have been tweaking their index-only fund portfolios.

In particular, the Bay Area-based adviser and money manager has been building positions in high-yield bonds and emerging market stocks, hoping to capitalize on temporary inefficiencies in the market.

"The market is generally efficient. But there are times when prices get out-of-whack with fundamentals. In the case of high-yield bonds, they sold-off dramatically in the fall of 2008," said Alice Lowenstein, the firm's director of managed portfolios. "When an asset class is really beaten down, our process assesses whether it's overdone."

Litman/Gregory manages about $2 billion in assets for outside advisers. It also runs another $2 billion in private accounts and through its Masters' Select family of mutual funds. Besides offering actively managed portfolios, the firm also creates model portfolios which are index-based.

With its index-based portfolios, Litman/Gregory started raising positions in junk bond funds last October by 3-5%, depending on risk levels. In late November 2008 and mid-February 2009, they added to those positions. Both times, the firm's managers used proceeds from the sale of U.S. equities to bump up allocations in bonds to a high-point of 15% in the most aggressive portfolios.

"In most of the scenarios we can envision right now over the next three- to five-years, high-yield bonds as an asset class looks more attractive than even equities," said Lowenstein. "Of course, conditions can change very quickly in these types of conditions. But we continue to own high-yield bonds and believe their significant yields can offer a short-term cushion if the market falls."

With junk, the firm's 10-member analyst team builds scenarios to test the impact of factors such as how rising default rates and interest rates can impact yield spreads as well as longer-term performance.

"We don't try to predict any particular outcome. We simply try to build models of what we might see happen," said Lowenstein. "Baked into those scenarios are macroeconomic trends that could impact valuations and earnings growth for stocks, for example."

The firm's managers in May also shifted some stock assets into emerging markets, bumping those allocations to between 3-7%, says Lowenstein.  Such a tactical move was funded by taking assets from a combination of U.S. and developed international stock fund positions.

Lowenstein says that those kinds of tactical moves only come when analysts see "fat pitches" coming investors' way. "Unlike baseball, you don't have to swing if it isn't a great pitch," she said. "So we don't unless our confidence level is pretty high."

In a model index-based portfolio with a neutral target allocation of 60% stock and 40% bonds, Litman/Gregory currently has:

• 42.5% in investment-grade bonds through the iShares Barclays Aggregate Bond Index (NYSE: AGG).

• 12% in various junk bond mutual funds.

• 27.5% in large-cap domestic stocks through the iShares S&P 500 Index (NYSE: IVV) and the iShares S&P 100 Index (NYSE: OEF).

• 2% in small-cap stocks through the iShares Russell 2000 Index (NYSE Arca: IWM). That's about 8 percentage points less than the portfolio's neutral position---anunderweight position that has been in-place for awhile.

• 11% in international stocks . That's just 1 percentage point less than the portfolio's long-term neutral weighting. In that asset class, the firm prefers to use the Vanguard FTSE All-World ex-US ETF (NYSE: VEU).

• 5% in emerging market stocks, using the Vanguard Emerging Markets ETF (NYSE: VWO).

With 54.5% of the portfolio in bonds, it might seem that the portfolio is nearly 15% overweight fixed-income. But that's true only true when junk and investment grade bonds are grouped together. Studies have shown that junk as a group is more correlated to equities than most other types of bonds.

"In this case, we're not allocating our fixed-income assets (in investment-grade) to a more risky asset class (in junk bonds). Instead, we took some of our holdings in equities to fund bigger positions in high-yield," said Lowenstein.

Last year, asset class valuations and scenarios for potential longer-term returns were shaken dramatically by the market's huge fall, she added.

"Starting from mid-September of 2008 when the financial crisis really grew in scope, we made about five tactical changes through year's end. But that's very unusual," said Lowenstein. "Normally, we wouldn't see that much activity in a whole year."

According to Litman/Gregory's calculations, its index-based model 60/40 model portfolio has outperformed its benchmark by a significant amount over time. Since the portfolio's inception on Jan. 1, 2002, it had returned an average annualized 3.12% through April. That compared to its benchmark's total return of 2.14%.

The firm uses a benchmark for its 60/40 model, which it refers to as the balanced portfolio, consisting of the following:

• The Vanguard Total Bond Market Index Fund (VBMSX), 40%.

• The Vanguard 500 Index (VFINX), 40%.

• The iShares Russell 2000 Index (NYSE Arca: IWM), 8%.

• The Vanguard Total International Stock Index Fund (VGTSX), 12%.

"We primarily employ ETFs in our index-based portfolios," said Lowenstein. "But our benchmarks use a combination of index mutual funds and ETFs."

Either way, she says Litman/Gregory stresses low-priced and well-managed vehicles of both types. "We recommend that advisers take a common sense approach in applying factors such as account sizes, trading costs and investment strategies when choosing between ETFs and index mutual funds in individual portfolios," said Lowenstein.

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

Stan Richelson and his wife, Hildy, run Scarsdale Investment Group Ltd. The Blue Bell, Penn.-based firm oversees about $130 million in U.S. bond portfolios for individual investors. The pair has written four books on the topic of investing in bonds. For the past 25 years, they've been advocating the case for bonds versus stocks as core holdings.

IndexUniverse.com's Murray Coleman recently caught up with Stan Richelson to discuss prospects for bonds going forward and their proper place in long-term portfolios.

IU: Did Rob Arnott's recent article in the Journal of Indexes validate work you've been doing for years?

Richelson: It was the best article I've ever read. It has not only validated our approach, but it has improved my life immensely.

IU: How so?

Richelson: When clients of ours used to speak to friends and family and explain that they were investing in our all-bond portfolios, they'd tell them they were crazy. So in the past, we had to tell our clients to keep it to themselves—they don't deserve that kind of abuse.

IU: What has been the response of your peers?

Richelson: Other fee-only advisers have been telling us for years that we were unprofessional because we didn't allocate assets the way they did. But after two stock market collapses in the last nine years, all of a sudden we've become very popular. Everyone wants to talk to us now—we're getting quoted in all sorts of publications. Our views have been the same for 25 years. It's finally starting to sink in with more people that their belief in stocks always outperforming bonds is all just a giant erroneous paradigm. And what's so huge about the Arnott article is that he goes back more than just 40 years. He looks back at various periods over the past 200 years to show that bonds have outperformed stocks during many longer periods.

IU: How has Arnott's work helped to advance previous studies on fixed-income?

Richelson: The Arnott article said that bonds have outperformed stocks over the past 10, 20 and 40 years. We didn't have that article when we wrote our last book, "Bonds: The Unbeaten Path To Secure Investment Growth," when we working on it during late 2006 and early 2007. We used the Ibbotson data which said that since 1926, stocks provided an average annualized return of about 10% and long-term Treasuries returned about 5%. So you'd think that stocks greatly outperformed bonds. But what the Ibbotson data didn't take into account was the impact of income taxes, fees and expenses on returns for individual investors. The Ibbotson data also doesn't properly account for the bad timing of individuals in timing stock markets. If you compare stocks to tax-free muni bonds, for example, that 10% return for stocks just doesn't hold up over time. If you include those three factors—taxes, fees and bad timing—you see that the stock return comes down to about the return on a tax-free muni bond. That is the theme of the first chapter of our bond book.

IU: In your latest book, you also compare risk-adjusted returns between stocks and bonds, don't you?

Richelson: Yes, when you adjust for the risk of stocks as compared to high-grade bonds, there really isn't any comparison. Bonds are much safer. We're not discussing junk or anything of that sort.

IU: If you had all of this research already, what did Arnott's article add?

Richelson: Our comparison of stocks and bonds was very untraditional. Nobody ever challenged the Ibbotson data. I'm sure it's correct as far as it goes. What we did was to make some adjustments. What Arnott did was use Wall Street's methodology exactly as Wall Street compares stocks and bonds. He used long-term Treasuries and compared it to the S&P 500, including dividends, and marked to market in the traditional way every year. So he more than confirmed what we'd been telling people for years.

IU: Couldn't a case be made that this is all data mining?

Richelson: Keep in mind that the markets came to a crossroad in October 2008. In the last quarter of 2008, the stock market collapsed and, at the same time, interest rates on Treasuries declined substantially resulting in Treasuries appreciating substantially.

IU: Are you saying that the long-term returns for stocks would've looked much better a year ago?

Richelson: Sure. If you go back to 2007, the S&P 500 was at an all-time high. The conventional wisdom is two-fold: stocks have always outperformed bonds; if you take any 10-year rolling period, you found that stocks never had a loss. At the point when Arnott collected his data, he found an extraordinary thing: When you go back 10 years, bonds outperformed stocks. He then counted back 20 years and then 40 years. In each time period, bonds outperformed stocks. He then took a huge stab at Jeremy Siegel by asking: So what's the long run?

IU: But if you looked at a different time period such as 2007, then things would look much different wouldn't they?

Richelson: They probably would. But if you would've asked anyone at the beginning of February 2009 which asset class would've done better in the past 40 years, how many would've picked bonds? The Arnott article put bonds on a more level playing field with stocks. The key point as I see it is that if stocks haven't outperformed in the past, why would you think that they'd outperform in the future? What we suggest in our latest book is that individuals need to keep a more open mind. Stocks might outperform in the future, but so might bonds. And even if stocks outperform going forward, for the increased risks you take, bonds are a superior asset class for individual investors.

IU.com: So what do you see as a proper asset allocation for individual investors?

Richelson: We believe a 100% allocation to bonds is appropriate and proper. If there's no proof that stocks will outperform bonds going forward, why not protect your principal and know what you have, particularly in the current environment of recession and fear?  I never thought you could do a proper financial plan with stocks—there's just too much uncertainty. The return on our muni-bond portfolios went up by about 50% on an after-tax basis over the past seven-and-a-half years. That sounds like a lot, doesn't it? But all that comes out to is around 4.5% on a compounded yearly basis. But it sure beat stocks. And if interest rates stay around 4.5% over the next seven-to-eight years, we'll earn another 50% after tax. That's our definition of investing—you know when you're going to get your money back and you know what the rate of return is going to be at all times. Everything else is speculation.  any financial planners who are creating financial plans heavily weighted with stocks and significant expected rates of return are guessing. That's not the way to plan someone's future.

In another reduction of alternative indexes that use different valuations and business fundamentals to weight companies, Claymore Advisors is seeking to switch an existing exchange-traded fund to a more traditional market-cap size weighted benchmark.

But that isn't all.

In a filing dated May 21, the trust for the Claymore/Great Companies Large-Cap Growth ETF (NYSE: XGC) is asking the Securities & Exchange Commission to let it invest in much smaller companies. And while listed largely on U.S. exchanges, they'd be foreign-based businesses.

The new fund would be called the Claymore/BNY Mellon International Small Cap ETF.

The document notes that the new ETF's "investment objective is not fundamental" in nature. It clearly states the change will revert to a strictly passive indexing approach. (See filing here.)

The request to regulators by Claymore comes on the heels of PowerShares' decision to close 19 of its ETFs, a dozen of which were based on fundamental indexes created by Rob Arnott's Research Affiliates. (See related story here.)

While the existing XGC also follows an index, it's based on an investment approach by Great Companies Inc., a Tampa Bay, Fla.-based money management firm. Its managers rank companies by such factors as price-earnings growth rates, or PEG ratios, and various debt measures for assessing profitability.

Great Companies uses computers to crunch fundamental data to compare value characteristics against growth metrics for domestic large-cap names. Stocks are ranked and added to the ETF's underlying index according to the adviser's composite scoring system.

When it was launched in April 2007, XGC came with an expense ratio of 0.60%. It hasn't changed since then and it had slightly more than $3.7 million in assets through Tuesday.

Higher Price Tag 

When it was first coming to market, a Great Companies' portfolio manager acknowledged that XGC's price tag was higher than rival large-cap funds such as Vanguard and iShares. "But we're providing more of a managed-account product than a classic index-fund product," he said in a MarketWatch.com story at the time. (You can read the story here).

The new small-cap international ETF would face stiff competition as several newcomers have jumped into the asset class in the past few years. But one bone of contention for U.S.-based investors in often illiquid foreign waters is that it can be difficult to follow small-cap names held by their funds.

The new Claymore offering would address that concern by predominately investing in overseas firms with listings on major U.S. exchanges. The fund would hold mainly companies with American depositary receipts or global depositary receipts and market caps of $250 million to $2 billion.

At the end of March, such a makeup gave the underlying index a definite slant to emerging markets. The BNY/Mellon benchmark consisted of 92 stocks. The weightings by country then were: Brazil 21.37%; China 19.20%; India 7.28%; United Kingdom 6.88%; Chile 5.59%; Mexico 4.19%; Russia 3.64%; Japan 3.40%; Israel 3.10%; Netherlands 2.78%; Greece 2.64%; South Africa 2.57%; Italy 2.14%; Argentina 1.98%; Switzerland 1.96%; France 1.89%; Korea 1.79%; Australia 1.68%; Ireland 1.61%; Colombia 1.51%; Hungary 1.00%; U.S. 0.82%; Indonesia 0.50%; Hong Kong 0.46%; Denmark 0.45% and Germany 0.41%.

No expense ratio is listed in the filing. But if the new fund were in the same neighborhood as XGC's, it would seem to have a better fighting chance when competing in the small-cap international arena.

Prices for rival ETFs range from around 0.40% and up. For example, the group's granddaddy is the WisdomTree International SmallCap Dividend Fund (NYSE: DLS). Meanwhile, Vanguard entered the field in March with an ETF charging 0.38%. (For a more complete breakdown on competing international small-cap ETFs, see stories here and here.)

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

Ron Pernick is co-founder and managing director of Clean Edge Inc. The San Francisco area-based consultant and researcher creates indexes to track various segments of the clean energy industry. One of its benchmarks serves as the basis for the PowerShares Global Wind Energy Portfolio (NASDAQ: PWND).  

IndexUniverse.com's Murray Coleman caught up with Pernick recently at Clean Edge's offices in Portland, Ore., working on development of a new index series expected to be unveiled by year's end.

IU.com: What do the correlations between conventional energy pricing trends and alternative energy trends show now?

Pernick: Conventional energy prices are extremely volatile. Over time, you can make the case that those will continue to increase, especially oil. On the other hand, clean energy prices in general have been going down. Solar power is a very striking example. For every doubling of solar PV modules [the technology used to convert sunlight into electricity], there's about an 18% decline in pricing.

IU.com: Is that a big change from past years?

Pernick: In 2007, for the first time, the solar industry started using more silicon than the high-tech semiconductor industry. From 2006 through 2008, we saw a significant shortage of silicon. But that three-year period is ending, which will further help to reduce costs of solar energy going forward. Some of the large manufacturers such as Suntech Power (NYSE: STP) last year started initiating price reductions of around 25% on solar cells and panels. And we're seeing more price reductions this year. That bodes well for the solar industry and solar PV modules in the future. We're also seeing companies like First Solar (Nasdaq: FSLR) delivering thin-film solar technologies now that are cheaper. That's a neat twist in the non-silicon, new chemistries market.

IU.com: How about wind energy?

Pernick: Over the past 30 years, we've seen a reduction in pricing in wind power. But now it's stabilizing. We probably won't see significant ongoing wind reductions in terms of costs. It could decrease slightly or remain stable. The key is that wind power has taken a maturation path where there are large players who've been working on large projects for years. Those include companies such as GE (NYSE: GE) and Siemens AG (NYSE: SI).

IU.com: As clean energy costs go down, how much will its usage escalate?

Pernick: My crystal ball is no better than anyone else's might be at making predictions. But many drivers are in place to increase usage in the United States. More than two dozen states already have renewable portfolio standards, which require states to produce clean electricity at certain levels. For example, California is requiring 33% of all electricity produced in the state to come from renewable sources by 2020. And a number of states are pegging that rate at 20-25% by 2025. Today, between 8-10% of our electricity generation in the U.S. comes from renewable energy. That figure includes hydropower. It's important to remember that most of these state mandates don't include hydro.

IU.com: What do you see as the biggest gainers from such a development?

Pernick: There's no doubt wind is going to be a big benefactor of this push on a statewide level. There are 12 states, in particular, that appear to be well-positioned. Those include Texas and Iowa, of course, along with almost anywhere across the Great Plains. Also, the three Western states stand to gain along with those in the Eastern coastal parts of the country. Wind prices are relatively stable now, which is a plus for states looking to plan projects on a larger scale.

IU.com: What about solar power?

Pernick: Considering that solar costs are positioned to drop dramatically in the next several years, we could easily get to a point where solar might represent 10% of the country's electricity generation by 2025. But that can only happen with utilities actively involved in the process. Other industries also must take the right steps in terms of gaining proper access and receiving enough incentives to fully take advantage of new solar technologies. It's important to note that in the past five years, the most activity we've seen in the U.S. in terms of solar adoption has been from commercial and industrial buildings putting systems on roof tops.

IU.com: How is new legislation impacting new projects?

Pernick: The last two quarters of 2008 and the first quarter of 2009 were pretty dismal. The decimated credit markets didn't help alternative energy sectors. But we're starting to see the impact of stimulus dollars and more liquidity in credit markets show up in a number of different ways. For example, the stimulus package includes over $9.3 billion to improve high-speed rail. To build a smarter grid system, another $11 billion is targeted in the stimulus bill. In total, we've identified more than $70 billion from this stimulus package for clean energy projects alone. If you add clean water spending into the mix, that goes up to close to $90 billion.

We also should see some stimulus coming as the result of an eight-year extension for solar tax credits. The most we've seen in terms of extensions in the past have been two years. And it often takes a long time to actually receive an extension. So this eight-year period should provide a lot more clarity in lowering costs for people to install solar power.

But we don't expect any of these drivers to make a big impact on clean energy industries until early 2010. So while we're starting to see some increased activity, it's going to take some time to recover from the ravages of the recent bear market.  

IU.com: What is the most attractive subsegment of renewable energy market?

Pernick: Some other areas of interest are conservation and efficiency. By deploying these measures, you reduce the amount of electricity needed. Weatherizing a house, for example, is a great idea. How many people use a digital thermostat to automatically turn off their heat when they don't need it? And there are a lot of new energy efficient technologies coming down the road—including windows that can reduce cold or heat outflows by three-to-five times. Retrofits are great and a lot of programs are being developed to help people fund these types of projects.

But the really dramatic changes are coming in the green building arena with brand new structures. Anything embedding more intelligent and efficient systems in our power grid is going to make a huge difference. When there's a power outage today, utilities find out today by phone calls. In the future, utilities are going to use technologies that talk to each other. It's the next big networking project in high-tech.

(Editor's note: The following was submitted by IndexUniverse.com's Murray Coleman in San Francisco and IndexUniverse.EU's Paul Amery in London.)

The recently announced $4.4 billion deal by Barclays Global Investors to sell its exchange-traded funds business to private equity manager CVC Captial Partners could be in jeporday. 

Reports surfaced in London on Sunday that at least three new bids have surfaced. The Daily Telegraph is naming private equity groups Apax, BC Partners and Hellman & Friedman as parties expressing an interest in bidding more for iShares than the original terms offered by CVC Capital.

A Barclays spokesman told the paper that it was too early to tell if any new offers would turn into anything concrete. But he did tell reporter Philip Alrdick that there had been "tremendous" interest in iShares from "both strategic and private equity" since the initial deal was made public on April 9.

While the CVC agreement remains largely a done deal, there are caveats in the original terms that allow Barclays to shop for a better partner. Barclays has a 45-day window, which is set to expire on June 18, to look for alternative and superior offers. If Barclays finds a better offer, it will pay a $175 million breakup fee to CVC Capital. (See related story here.)

Barclays is financing the bulk of the CVC deal, providing loans on reasonably favorable terms for $3.1 billion of the $4.4 billion deal. So besides upping the ante in terms of the sales price, new bids could involve either better financing terms or less money to be thrown into the pot by Barclays itself. 

Even a little wiggle room either way could provide a huge incentive for Barclays' executives. The company's management would retain up to a 10% stake in iShares and be paid a cash dividend as part of the CVC deal. Barclays CEO Robert Diamond Jr. was expected to earn $6.9 million from the agreement.

The iShares business itself earned approximately $440 million in EBITDA profits in 2008 on revenues of more than $900 million. The value of the CVC agreement, according to BGI, is around a multiple of 10.1 times 2008 EBITDA.

The Telegraph story noted that a bidding war for iShares -- about one-fifth of BGI's total business -- should benefit shareholders of parent Barclays Plc. It added: "A higher bid will also increase the average windfall for the 200 staff with stakes in iShares ..."

On the day of the CVC deal's announcement, the current chief executive of BGI's iShares operations told IndexUniverse that the company was well-prepared to go it alone, both in terms of finances as well as resources. (See related story here.)

But any new deal could also alter the status of CEO Lee Kranefuss. As reported shortly after the CVC pact was signed, he would be bumped up to chairman with iShares being run on a day-to-day basis by co-CEOs.  (See related story here.)

None of the overseas reports offered any hints on whether talks with more potential suitors addressed management of iShares going forward. 

In the Sunday Times of London, reporter Matthew Goodman wrote that renewed bidding for iShares could bring even more offers -- perhaps from larger financial giants such as Charles Schwab & Co. He also pointed out that suitors who lost out in the initial auction such as Bain Capital and Colony Capital could decide not to jump back into the contest.

Interestingly, if the Telegraph's reports prove correct, Hellman & Friedman would fall into that category. They were a finalist in the bidding that appeared concluded in April. Earlier reports also listed Apax as a suitor, although that was never confirmed when negotiations moved into its final stages and CVC became the apparent winner. 

(Editor's note: The following was submitted by IndexUniverse.com's Murray Coleman in San Francisco and IndexUniverse.EU's Paul Amery in London.)

The recently announced $4.4 billion deal by San Francisco-based Barclays Global Investors to sell its exchange-traded funds business to private equity manager CVC Captial Partners could be in jeporday. 

Reports surfaced in London on Sunday that at least three new bids have surfaced. The Daily Telegraph is naming private equity groups Apax, BC Partners and Hellman & Friedman as parties expressing an interest in bidding more for iShares than the original terms offered by CVC Capital.

A report by the Sunday Times of London also listed BC Partners. In fact, the paper says that the firm is now willing to pay $5.3 billion for the ETF market's dominant provider. That would be closer to earlier estimates of what BGI's parent, Barclays Plc, wanted to gain from giving up its highly profitable iShares unit. 

A Barclays spokesman later in the day told journalists that it was too early to decide if any new offers have enough substance to turn into anything concrete. But he added that there had been "tremendous" interest in iShares from "both strategic and private equity" since the initial deal was made public on April 9, according to a Reuters article.

While the CVC agreement remains largely a done deal, there are caveats in the original terms that allow Barclays to shop for a better partner. Barclays has a 45-day window, which is set to expire on June 18, to look for alternative and superior offers. If Barclays finds a better offer, it will pay a $175 million breakup fee to CVC Capital. (See related story here.)

Barclays is financing the bulk of the CVC deal, providing loans on reasonably favorable terms for $3.1 billion of the $4.4 billion deal. So besides upping the ante in terms of the sales price, new bids could involve either better financing terms or less money to be thrown into the pot by Barclays itself. 

Even a little wiggle room either way could provide a huge incentive for Barclays' executives. The company's management would retain up to a 10% stake in iShares and be paid a cash dividend as part of the CVC deal. Barclays CEO Robert Diamond Jr. was expected to earn $6.9 million from the agreement.

The iShares business itself earned approximately $440 million in EBITDA profits in 2008 on revenues of more than $900 million. The value of the CVC agreement, according to BGI, is around a multiple of 10.1 times 2008 EBITDA.

The Telegraph story noted that a bidding war for iShares -- about one-fifth of BGI's total business -- should benefit shareholders of parent Barclays Plc. It added: "A higher bid will also increase the average windfall for the 200 staff with stakes in iShares ..."

On the day of the CVC deal's announcement, the current chief executive of BGI's iShares operations told IndexUniverse that the company was well-prepared to go it alone, both in terms of finances as well as resources. (See related story here.)

But any new deal could also alter the status of CEO Lee Kranefuss. As reported shortly after the CVC pact was signed, he would be bumped up to chairman with iShares being run on a day-to-day basis by co-CEOs.  (See related story here.)

None of the overseas reports offered any hints on whether talks with more potential suitors addressed management of iShares going forward. 

In the Sunday Times, reporter Matthew Goodman observed that renewed bidding for iShares could bring even more offers -- perhaps from larger financial giants such as Charles Schwab & Co. He also pointed out that suitors who lost out in the initial auction such as Bain Capital and Colony Capital could decide not to jump back into the contest.

Interestingly, if such reports prove correct, Hellman & Friedman would fall into that category. They were a finalist in the bidding that appeared concluded in April. Earlier reports also listed Apax as a suitor, although that was never confirmed when negotiations moved into its final stages and CVC became the apparent winner. 

Ed Yardeni is president of Yardeni Research  Inc., a provider of independent investment strategy research and data. He has worked as chief investment strategist at Deutsche Bank, Prudential Equity Group and Oak Associates. Yardini has also served as chief economist for C.J. Lawrence, Prudential Securities and E.F. Hutton.  

His resume also includes working as an economist with the Federal Reserve Bank of New York. He also held positions at the Federal Reserve Board of Governors and the U.S. Treasury Department.

Earlier this week, IndexUniverse.com's Murray Coleman caught up with the market-oriented economist and investment analyst Thursday afternoon to find out his take on macrotrends going forward.

IndexUniverse.com: Does this rally have legs?

Ed Yardeni:  I think it does. It has already traveled a fair distance. I think 1,000 on the S&P 500 is likely. We're probably going to take-out the Jan. 6 high for the year fairly soon, which was 934.70.

IU: Do you see more bumps in the round?

Yardeni: Yes, but they're the same bumps we've seen in the bear market. The banking system still has its issues as evidenced by the most recent stress test given by the government. And unemployment is still a concern. But there's a sense that these problems might not stop the economy from recovering after all.

IU: Do you see a pullback coming, though?

Yardeni: I don't try to be a technician. But sure, there could be a pullback. Remember, though, that we're coming back from a huge fall. What is encouraging is that stock prices in many industries are gaining back their losses from the September 2008 levels. That's when Lehman and AIG really hit the fan and panic took over.

IU: What sectors seem the best-positioned at this point?

Yardeni: Being defensive doesn't make much sense with a global recovery in sight. So I think materials and industrials should do well. The price of oil has done well recently. It should continue to rise. In the next six- to 12-months, prices could get up into the $75-$80 per barrel range. The metals and mining as well as specialty chemicals also look attractive now. Diversified chemicals still appear rather sluggish and I don't see a lot of upside in that industry.

IU: Do you think gold has more room to run?

Yardeni: Not necessarily. Gold and the trade-weighted U.S. dollar have been flight-to-safety plays. We've seen more interest in risk-taking lately. If that continues to be the case, the trade-weighted dollar and gold may go nowhere fast. I'm not enthusiastic about either one at this point.

IU: How about emerging markets?

Yardeni: They've had a great run and I think they'll continue to outperform from here. We started to see at the beginning of this decade a great global boom. That was interrupted by the credit crisis, but it looks like global growth might be resuming again. China, India and Brazil look best at this point. Asia will be the region that really leads the global economy out of this recession, more so than the U.S., Japan or Europe.

IU: How do you see Europe?

Yardeni: It's going to be a slow-growth story. They don't have much going on over there in terms of domestic demand. The demographics are against them with an aging population. And on the whole, they tend to have a more conservative consumer base. Other than in Spain, the U.K. and a scattering of other countries, Europe hasn't seen the kind of housing boom in recent years as the U.S. underwent this decade. Eastern Europe seems to continue to be mired in some of the credit excesses they've been through in recent years.

IU: What do you see taking place in those markets where housing did spurt before the credit crisis?

Yardeni: Now that we've seen the housing bubble burst, economies that used to have very active real estate markets -- such as Spain, the U.K. and Ireland -- are going to slow even more.

IU: Which markets appear in relatively better shape in Europe?

Yardeni: France and Germany have been heavily reliant on exports. But they should show better strength than other European countries because a global recovery will provide a lift to their exporting capabilities. That should put them in a better relative position than Spain, Ireland and the U.K.

IU: What sort of chance to do you see for a turnaround in Japan?

Yardeni: Not much. The main hope for Japan is strong growth in China. They've got one of the worst demographic situations of any industrialized economy. And they don't have any real serious domestic demand. They're working on their second lost decade. Japan stands to lose much of their economic influence in the next decade.

IU: What about the U.S.?

Yardeni: This is going to be the first global recovery not led by the U.S. Our economy will recover, but it will be lackluster and take some time to complete. The good news is that the U.S. remains a very dynamic economy. We've still got plenty of entrepreneurs who are going to make money even with the government playing a larger role in the private sector. But even once employment growth builds, we still could be looking at a recovery about half the strength of what we've seen in the past.

IU: What other types of investments are you recommending to institutional investors these days?

Yardeni: Corporate bonds, junk bonds and leveraged loans all look interesting. If you can get involved in funds that invest in companies benefitting from TALF, those would seem to be an attractive way to invest right now. That's assuming that you think that we're on a course heading towards a global recovery. I certainly do, which makes me believe that some sectors considered at the moment to be more risky look very attractively priced. This would seem to be a good time to take advantage of some of those opportunities.

David Morris is chief executive of London-based Global Wealth Allocation Ltd., an asset management and research firm with around $3 billion in assets under management. He began his career by serving in economic development for the Canadian government in East Africa. In 1980, he took over as treasury manager for Xerox's Canadian operations. Then, six years later, he became treasurer for Campbell Soup in Canada. Morris later started a pension consultancy business. In 1992, he founded GWA.

Morris is probably best known for developing a series of 20 indexes that are sold worldwide in partnership with the FTSE Group. The benchmarks, which were created in 1996, are "wealth-weighted." GWA takes standard FTSE indexes and weights components based on three valuation measures: net profit, cash flow and book value.

IndexUniverse's Murray Coleman recently caught up with the economist-turned-index-developer to discuss his views on global corporate profits and market pricing of those assets.

IndexUniverse.com: Why do you focus on net profits and two other valuation metrics in creating indexes?

Morris: I didn't grow up, so to speak, as a fund manager. My education is as an economist and my work experience prior to GWA was as a treasurer in corporate finance. Most of my background has been focused on analyzing how corporations run their balance sheets—not modern portfolio theory. I look at how all of the tools, machines and equipment in society—the stock of capital—is used to produce a flow of goods and services. That is on a country-by-country, regional and global basis.

IU: What does your research tell you about current market conditions?

Morris: The limit to growth in the market, of course, is the amount of wealth being created at any given time. If we measure wealth consistent with economic macro theory, then we can look at the wealth in markets and compare that to current pricing levels. For example, in metals we're seeing a collapse in share prices underpinning the basic materials sector.

IU: Has that collapse been matched by a similar deterioration in the corporate profits?

Morris: No, global market prices for basic materials producers indicate that investors expect future wealth creation to decline materially by 35% or more in that sector. But the probabilities favor a recovery of prices rather than a further deterioration of wealth creation.

IU: What brings you to that conclusion?

Morris: We've just been told the Chinese are accumulating strategic materials now at a phenomenal rate. That will support the market pricing for metals. In effect, demand in China should put a floor on metals pricing going forward.

IU: So this is a significant new dynamic coming into play for basic materials and metals manufacturers?

Morris: Yes, considering that the bubble in metals prices that burst in 2007 was driven pretty much by economic development in China. For the decade ended in 2004, China's demand drove lead prices, for example, up almost five times greater than in the past decade. And copper prices expanded by over six times the previous decade's highest levels.

IU: When China's economic activity slowed in 2007, then demand and world metals prices dropped?

Morris: Yes, and they dropped by a large amount. Even though copper prices have rallied by 38% since December [2008], the market still doesn't seem to believe that demand has rebounded enough. But as we've just learned from recently released first-quarter [2009] data, China has purchased something like 20-25% of the world's total copper production. In that same time, copper prices went up about 45%.

IU: What do you see taking place in the financial sector?

Morris: Stock prices in developed markets for financials have dropped about 70% since July 2007. It's interesting to note that we've seen an almost identical deterioration in the sector's net profits and cash flow. In nonfinancials among developed markets, we've seen the same 70% erosion in prices. However, we haven't seen a similar deterioration in earnings. That indicates investors are punishing nonfinancials as much as financials. Today's market pricing is suggesting that investors expect another 50%-plus erosion in nonfinancial corporate profits from current levels. That would put corporate profits about at a level where they were a decade ago.

IU: How much have nonfinancial profits actually fallen?

Morris: Across global developed markets, nonfinancial prices have dropped about 15% off their peak levels. So broadly speaking, there's a huge gap between market pricing and actual corporate profits in those segments. More specifically, it appears that investors are punishing basic materials manufacturers especially hard.

IU: But you consider nonfinancial stocks to be priced fairly now, don't you?

Morris: Yes, and the 55% gap between how much prices have dropped for nonfinancials so far and the actual falloff in corporate profits signify the future for investors. In other words, that 55% gap represents the potential upside in nonfinancials going forward. But that's based on an assumption that no other significant material events will occur to cause a major contraction in corporate profits. But if that does happen, at this point, the downside seems limited because the market has already taken a 55% greater hit than actual earnings and cash flow measurements would justify.

IU: The majority of downside risk for investors globally will continue to come in financial sectors then, won't it?

Morris: Yes, going forward there could be some real nasty surprises. But that's likely to hurt financial balance sheets much more than nonfinancials, considering that financials have fallen by so much at this point. And the limit to that risk is the positive yield curve that is benefiting banks right now.

IU: How do you see bond yields impacting the profit picture for banks across the developed world?

Morris: With 90-day Treasuries yielding around 11 basis points today, and 30-year Treasuries yielding about 400 basis points, financial institutions can borrow at short-term rates—that is, take deposits—while lending at longer-term rates. So they've got a built-in profit margin right now in the lending business. 

IU: But banks are being criticized for not lending enough, aren't they?

Morris: We keep reading that. But the total assets in the world banking system are just under [U.S.] $60 trillion. So even if bank lending shrinks a little, that positive yield curve is still working with an enormous base of assets.

IU: So as long as yield curves remain positive, that will act as a floor to losses in the financial sector?

Morris: Yes, that would seem to be the case. Remember that when the credit crisis began in the summer of 2007, the yield curve was inverted almost everywhere in the world. You can debate the merits of Ben Bernanke's short reign as chairman of the U.S. Federal Reserve's board. But give him credit—he did manage to get the yield curve to turn positive in the span of a little more than 18 months. Consider that in June 2007, 90-day Treasury notes were yielding 480 basis points, and 30-Year Treasury notes were around 505 basis points. So that put a huge squeeze on bank profits. That situation has been turned around and will prove to be a significant factor in the performance of financials as a whole in coming quarters.

David Morris is chief executive of London-based Global Wealth Allocation Ltd., an asset management and research firm with around $3 billion in assets under management. He began his career by serving in economic development for the Canadian government in East Africa. In 1980, he took over as treasury manager for Xerox's Canadian operations. Then, six years later, he became treasurer for Campbell Soup in Canada. Morris later started a pension consultancy business. In 1992, he founded GWA.

Morris is probably best known for developing a series of 20 indexes that are sold worldwide in partnership with the FTSE Group. The benchmarks, which were created in 1996, are "wealth-weighted." GWA takes standard FTSE indexes and weights components based on three valuation measures: net profit, cash flow and book value.

IndexUniverse's Murray Coleman recently caught up with the economist-turned-index-developer to discuss his views on global corporate profits and market pricing of those assets.

IndexUniverse.com: Why do you focus on net profits and two other valuation metrics in creating indexes?

Morris: I didn't grow up, so to speak, as a fund manager. My education is as an economist and my work experience prior to GWA was as a treasurer in corporate finance. Most of my background has been focused on analyzing how corporations run their balance sheets—not modern portfolio theory. I look at how all of the tools, machines and equipment in society—the stock of capital—is used to produce a flow of goods and services. That is on a country-by-country, regional and global basis.

IU: What does your research tell you about current market conditions?

Morris: The limit to growth in the market, of course, is the amount of wealth being created at any given time. If we measure wealth consistent with economic macro theory, then we can look at the wealth in markets and compare that to current pricing levels. For example, in metals we're seeing a collapse in share prices underpinning the basic materials sector.

IU: Has that collapse been matched by a similar deterioration in the corporate profits?

Morris: No, global market prices for basic materials producers indicate that investors expect future wealth creation to decline materially by 35% or more in that sector. But the probabilities favor a recovery of prices rather than a further deterioration of wealth creation.

IU: What brings you to that conclusion?

Morris: We've just been told the Chinese are accumulating strategic materials now at a phenomenal rate. That will support the market pricing for metals. In effect, demand in China should put a floor on metals pricing going forward.

IU: So this is a significant new dynamic coming into play for basic materials and metals manufacturers?

Morris: Yes, considering that the bubble in metals prices that burst in 2007 was driven pretty much by economic development in China. For the decade ended in 2004, China's demand drove lead prices, for example, up almost five times greater than in the past decade. And copper prices expanded by over six times the previous decade's highest levels.

IU: When China's economic activity slowed in 2007, then demand and world metals prices dropped?

Morris: Yes, and they dropped by a large amount. Even though copper prices have rallied by 38% since December [2008], the market still doesn't seem to believe that demand has rebounded enough. But as we've just learned from recently released first-quarter [2009] data, China has purchased something like 20-25% of the world's total copper production. In that same time, copper prices went up about 45%.

IU: What do you see taking place in the financial sector?

Morris: Stock prices in developed markets for financials have dropped about 70% since July 2007. It's interesting to note that we've seen an almost identical deterioration in the sector's net profits and cash flow. In nonfinancials among developed markets, we've seen the same 70% erosion in prices. However, we haven't seen a similar deterioration in earnings. That indicates investors are punishing nonfinancials as much as financials. Today's market pricing is suggesting that investors expect another 50%-plus erosion in nonfinancial corporate profits from current levels. That would put corporate profits about at a level where they were a decade ago.

IU: How much have nonfinancial profits actually fallen?

Morris: Across global developed markets, nonfinancial prices have dropped about 15% off their peak levels. So broadly speaking, there's a huge gap between market pricing and actual corporate profits in those segments. More specifically, it appears that investors are punishing basic materials manufacturers especially hard.

IU: But you consider nonfinancial stocks to be priced fairly now, don't you?

Morris: Yes, and the 55% gap between how much prices have dropped for nonfinancials so far and the actual falloff in corporate profits signify the future for investors. In other words, that 55% gap represents the potential upside in nonfinancials going forward. But that's based on an assumption that no other significant material events will occur to cause a major contraction in corporate profits. But if that does happen, at this point, the downside seems limited because the market has already taken a 55% greater hit than actual earnings and cash flow measurements would justify.

IU: The majority of downside risk for investors globally will continue to come in financial sectors then, won't it?

Morris: Yes, going forward there could be some real nasty surprises. But that's likely to hurt financial balance sheets much more than nonfinancials, considering that financials have fallen by so much at this point. And the limit to that risk is the positive yield curve that is benefiting banks right now.

IU: How do you see bond yields impacting the profit picture for banks across the developed world?

Morris: With 90-day Treasuries yielding around 11 basis points today, and 30-year Treasuries yielding about 400 basis points, financial institutions can borrow at short-term rates—that is, take deposits—while lending at longer-term rates. So they've got a built-in profit margin right now in the lending business. 

IU: But banks are being criticized for not lending enough, aren't they?

Morris: We keep reading that. But the total assets in the world banking system are just under [U.S.] $60 trillion. So even if bank lending shrinks a little, that positive yield curve is still working with an enormous base of assets.

IU: So as long as yield curves remain positive, that will act as a floor to losses in the financial sector?

Morris: Yes, that would seem to be the case. Remember that when the credit crisis began in the summer of 2007, the yield curve was inverted almost everywhere in the world. You can debate the merits of Ben Bernanke's short reign as chairman of the U.S. Federal Reserve's board. But give him credit—he did manage to get the yield curve to turn positive in the span of a little more than 18 months. Consider that in June 2007, 90-day Treasury notes were yielding 480 basis points, and 30-Year Treasury notes were around 505 basis points. So that put a huge squeeze on bank profits. That situation has been turned around and will prove to be a significant factor in the performance of financials as a whole in coming quarters.

Bob Doll has been chief investment officer of global equities at BlackRock Inc. since 2006. Before that he served in several portfolio management and executive investment positions with Merrill Lynch. Starting in 1999, he became chief investment officer of equities at Merrill Lynch Investment Management Americas. He later was promoted to co-head of that unit and senior vice president at Merrill Lynch. 

During a recent pause in market activity, IndexUniverse.com's Murray Coleman talked to the BlackRock CIO about his take on various sectors and asset classes.  

IU.com: Do you think this rally has legs?

Doll: Yes, over time. But it's not going to follow a one-way path heading straight up. There will be some rallies followed by some pullbacks—a lot of volatility still remains in the market. We think we've seen a bottom, however. The S&P 500's level of 666 on March 6 is the intraday low for this cycle. And it's important to remember that we've seen stocks advance 30% in a relatively short amount of time. So stocks are due for another breather.

IU.com: How does the fundamental picture for stocks look?

Doll: Green shoots are popping up here and there. But most of what we're looking at is still brown. The big black hole we've found ourselves in finally does appear to have a bottom, though. We think that while we're not going to see positive growth in the U.S. in the second quarter, it certainly will be less negative.

IU.com: What sectors look particularly attractive at this point?

Doll: We'd stick with a diversified portfolio. You need some cyclical, growth and defensive postures. Our cyclical favorite is energy now. We think the price of oil has probably found a bottom. As the world gets back on its feet at a slower growth rate, oil prices will slowly move higher. And the oil companies are selling fairly cheaply these days.

IU.com: How about your favorite sectors in terms of growth plays?

Doll: Our favorite growth sector is technology. It's the best sector year to date in the S&P 500. And that's pretty unusual in a recession. But these companies learned their lesson in the bursting of the tech bubble in 2000. These companies are managing their resources much more efficiently and that has led to their outperformance so far. It's definitely a leader and we think tech will continue to lead the way.

IU.com: And what about your favorite defensive sectors?

Doll: Health care is less popular and less expensive than the utilities and consumer staples areas. We think there are some growth prospects in health care, particularly in biotech and health care services. Many new products are in the pipeline for biotechs. And we don't believe that prices for biotech stocks are extraordinarily expensive yet. With health care services, we like the fact that they've shown reasonable subscriber growth and operating earnings progress.

The concern about health care as a whole is the unknown of the Obama administration's regulatory policies towards the sector. That has left a bit of a black cloud over those stocks. But our belief is that the market has penalized health care stocks enough to make the group's risk-reward prospects relatively healthy. So we would own the sector at this point.

IU.com: Do you see the U.S. outperforming foreign stocks going forward?

Doll: Yes, we think the U.S. will continue to outperform as it has for the past 15 months. But that's compared to other developed markets across the world. Emerging markets are likely to continue to do well and have fewer problems with credit and financial systems than most developed countries. So we think emerging markets will keep leading the way, even over U.S. stocks.

IU.com: How do you view China given recent revelations about apparent high-tech espionage efforts against U.S. infrastructure and military projects?

Doll: The political relationship among the current and emerging superpower will always be tricky. On the one hand, they need each other. At the same time, each is looking out of the corner of their eyes. The U.S. needs China to buy our Treasuries and China needs the U.S. for its consumption. So it's an unholy alliance.

IU.com: How do you see China as an investment at this point?

Doll: We're reasonably constructive on China as a whole. We think the economy has bottomed there as well. But its stocks have run up a lot in a hurry, so we'd prefer to invest in that market on a pullback. We're weighting China in our models at slightly higher than benchmark levels at the moment.

IU.com: How do you view alternative energy plays?

Doll: They're an interesting concept with interesting stories. And eventually, we believe they'll turn into interesting investment opportunities. But generally, this is an investment theme that has been pretty picked over at this point. So we're not rushing to buy into that part of the market. On the edges in bits and pieces, there are some interesting stories left. But at these prices, we'd prefer to wait for a pullback.

IU.com: How about gold and hard assets in general?

Doll: Investors need gold as a piece of their portfolio. For all that ails us, gold is a good hedge. We have significant positions in gold right now. But if we didn't, we'd be buyers now in that market. Generally, we feel that as the world gets back on its feet, demand for commodities will grow. We think you've got to be careful about your entry points. But for many commodities, we think we've seen the lows.

IU.com: What areas of fixed income do you favor?

Doll: Our long-term view is that Treasury yields will eventually move up. But that's a process that won't happen overnight. In fixed income, we think spreads are wide enough to make corporates worth owning on a risk-return basis. And we also think that the risk profiles of municipals are appealing given their current spreads over Treasuries. The downside risks of municipals seem to be priced into that market. If a depression hits, of course, all bets are off. But that's not something we're seeing as likely in our forecasts.

David Kreinces is a portfolio manager with ETF Portfolio Management. Before founding the Newbury Park, Calif.-based firm in 2007, he was a portfolio manager in Merrill Lynch's global private client group, specializing in absolute return strategies using exchange-traded funds.

Kreinces is one of a growing number of independent portfolio advisers offering all-ETF portfolios that implement hedging strategies.To find out more about his unique quantitative-based methodology, IndexUniverse.com's Managing Editor Murray Coleman recently caught up with him at ETF Portfolio Management's southern California headquarters.

IU.com: How do you implement ETFs in absolute return strategies?

Kreinces: Our strategies are built around quantitative, rules-based models. And they don't use leverage at all. That's an important point. By not using leverage, we feel like our ability to limit volatility and control portfolio risk is greatly enhanced. But this has been an unusual period. In the past 18 months, we've had record activity in terms of shifting positions. During this time, it has been rare for us to hold funds for more than a few weeks at a time. But this isn't designed as a short-term trading strategy.

IU.com: What's your fee structure for your various strategies?

Kreinces: Our core passive portfolios have no advisory fees. We offer three of these. One follows the basic recommendations for an all-ETF portfolio created by David Swensen, the manager of Yale University's endowment program. It basically follows the strategy described in his book, "Unconventional Success."

The second passive core portfolio is designed for novice investors and takes a more basic approach to diversification. A third passive portfolio takes a more diversified approach by not discriminating as much against emerging markets and commodities. Again, all three are passively managed buy-and-hold strategies using ETFs where our clients don't pay advisory fees.

IU.com: How do you make money then?

Kreinces: We make money because most clients, after seeing the results of our absolute return strategies, put at least a portion of their assets into those portfolios. After 2008, when the buy-and-hold strategy hit a pothole, about 90% of our client assets have moved into absolute return strategies.

IU.com: How much do you charge for those strategies?

Kreinces: Last year, we charged 50 basis points for our global growth model and 100 basis points for our long-short strategy and aggressive growth strategy. This year, they're all charging 200 basis points. That's because all of the strategies outperformed strongly in 2008. And we don't charge a performance fee.

IU.com: Can you provide a recent example of how you achieve positive returns in a down market?

Kreinces: Our global growth model in 2008 went into cash and stayed in cash for a large part of the year. When the model moved into equities, it was very selective about which ETFs it picked. Probably the broadly diversified ETFs we traded most often last year were the iShares MSCI Emerging Markets Index (NYSE: EEM), the iShares Russell 2000 Value Index (NYSE: IWN) and the iShares MidCap 400 Index (NYSE: IJH).

IU.com: What are you doing this year?

Kreinces: The global growth model is a long-only strategy. This year, it's long in large-cap growth. And what is driving that part of the market is technology. We use ETFs such as the PowerShares QQQ (Nasdaq: QQQQ) to capture large-growth with a tilt towards technology. We're also investing in emerging markets through EEM and the Vanguard Emerging Markets ETF (NYSE: VWO). But we continue to be very greatly invested in cash in the diversified global growth strategy.

IU.com: What are you doing in your aggressive growth strategy?

Kreinces: It's also a long-only absolute return strategy and rotates between sectors. Right now, it still has about a third of total assets in cash. In this model, we do have the ability to use more broad ETFs when the environment calls for it. That's the case now. We're using EEM with a heavy weighting on Brazil through the iShares MSCI Brazil Index (NYSE: EWZ). In this portfolio, we've also traded the Internet HOLDRS (NYSE: HHH). We don't hold them now, but our theme currently is to emphasize emerging markets and technology. We've traded SPDR Gold Shares (NYSE: GLD) and the iShares Silver Trust (NYSE: SLV) in this model as well. But we don't hold either of those right now.

IU.com: What about your long-short portfolio?

Kreinces: It invests in concentrated countries and sectors as well as commodities. It also has the capacity to step back and go into broader ETFs. This model can go 100% long or 100% short. Right now, it's 100% long. We're not holding any individual commodity ETFs right now, preferring to gain that exposure through Brazil and other emerging markets that are strongly influenced by natural resources.

IU.com: What has made you turn so bullish in that strategy?

Kreinces: When the market is trending upward as strongly as it has been, we try to capture as much of that as possible. So our long-short model hasn't been in cash during the past five weeks. We're very much trying to listen to what the market is telling us. The nature of our long-short model—along with the other models—is that it doesn't try to outguess markets. We're clearly in an uptrend and that pattern hasn't broken enough to send us back to cash yet.

IU.com: You also have an overlay for your models based on your own views, don't you?

Kreinces: Yes, but that overlay is implemented only when markets are at extreme levels. Right now, our more subjective judgments are being used to override our objective, rules-based quantitative processes only to a very limited degree.

IU.com: Why is that?

Kreinces: Our goal is to follow our rules-based methodology as much as possible. But when the markets shock our models, we don't want to get whipsawed around—that's expensive. So part of our risk controls are to allow for some sort of logical override to prevent severe losses of capital. We've got limitations on our threshold for pain. If our models aren't able to keep risks within a certain range, then we'll step in. Lately, we've been overriding the models in our core alpha strategy to try to stay out of the markets.

IU.com: How defensive are you in those types of composite portfolios?

Kreinces: Right now, we're about 85% long in our core alpha model, which equal-weights the other three strategies into a single, blended portfolio. The effort to fight the current rally reflects the fact that we were down in the mid-single digits in the first quarter in the core alpha strategy. That's a big drawdown for us. So as markets started rallying, we've participated in a very conservative fashion. The core alpha strategy is down slightly for the year. So we've eaten away at the drawdown, which is giving us a progressively bigger risk appetite.

David Kreinces is a portfolio manager with ETF Portfolio Management. Before founding the Newbury Park, Calif.-based firm in 2007, he was a portfolio manager in Merrill Lynch's global private client group, specializing in absolute return strategies using exchange-traded funds.

Kreinces is one of a growing number of independent portfolio advisers offering all-ETF portfolios that implement hedging strategies.To find out more about his unique quantitative-based methodology, IndexUniverse.com's Managing Editor Murray Coleman recently caught up with him at ETF Portfolio Management's southern California headquarters.

IU.com: How do you implement ETFs in absolute return strategies?

Kreinces: Our strategies are built around quantitative, rules-based models. And they don't use leverage at all. That's an important point. By not using leverage, we feel like our ability to limit volatility and control portfolio risk is greatly enhanced. But this has been an unusual period. In the past 18 months, we've had record activity in terms of shifting positions. During this time, it has been rare for us to hold funds for more than a few weeks at a time. But this isn't designed as a short-term trading strategy.

IU.com: What's your fee structure for your various strategies?

Kreinces: Our core passive portfolios have no advisory fees. We offer three of these. One follows the basic recommendations for an all-ETF portfolio created by David Swensen, the manager of Yale University's endowment program. It basically follows the strategy described in his book, "Unconventional Success."

The second passive core portfolio is designed for novice investors and takes a more basic approach to diversification. A third passive portfolio takes a more diversified approach by not discriminating as much against emerging markets and commodities. Again, all three are passively managed buy-and-hold strategies using ETFs where our clients don't pay advisory fees.

IU.com: How do you make money then?

Kreinces: We make money because most clients, after seeing the results of our absolute return strategies, put at least a portion of their assets into those portfolios. After 2008, when the buy-and-hold strategy hit a pothole, about 90% of our client assets have moved into absolute return strategies.

IU.com: How much do you charge for those strategies?

Kreinces: Last year, we charged 50 basis points for our global growth model and 100 basis points for our long-short strategy and aggressive growth strategy. This year, they're all charging 200 basis points. That's because all of the strategies outperformed strongly in 2008. And we don't charge a performance fee.

IU.com: Can you provide a recent example of how you achieve positive returns in a down market?

Kreinces: Our global growth model in 2008 went into cash and stayed in cash for a large part of the year. When the model moved into equities, it was very selective about which ETFs it picked. Probably the broadly diversified ETFs we traded most often last year were the iShares MSCI Emerging Markets Index (NYSE: EEM), the iShares Russell 2000 Value Index (NYSE: IWN) and the iShares MidCap 400 Index (NYSE: IJH).

IU.com: What are you doing this year?

Kreinces: The global growth model is a long-only strategy. This year, it's long in large-cap growth. And what is driving that part of the market is technology. We use ETFs such as the PowerShares QQQ (Nasdaq: QQQQ) to capture large-growth with a tilt towards technology. We're also investing in emerging markets through EEM and the Vanguard Emerging Markets ETF (NYSE: VWO). But we continue to be very greatly invested in cash in the diversified global growth strategy.

IU.com: What are you doing in your aggressive growth strategy?

Kreinces: It's also a long-only absolute return strategy and rotates between sectors. Right now, it still has about a third of total assets in cash. In this model, we do have the ability to use more broad ETFs when the environment calls for it. That's the case now. We're using EEM with a heavy weighting on Brazil through the iShares MSCI Brazil Index (NYSE: EWZ). In this portfolio, we've also traded the Internet HOLDRS (NYSE: HHH). We don't hold them now, but our theme currently is to emphasize emerging markets and technology. We've traded SPDR Gold Shares (NYSE: GLD) and the iShares Silver Trust (NYSE: SLV) in this model as well. But we don't hold either of those right now.

IU.com: What about your long-short portfolio?

Kreinces: It invests in concentrated countries and sectors as well as commodities. It also has the capacity to step back and go into broader ETFs. This model can go 100% long or 100% short. Right now, it's 100% long. We're not holding any individual commodity ETFs right now, preferring to gain that exposure through Brazil and other emerging markets that are strongly influenced by natural resources.

IU.com: What has made you turn so bullish in that strategy?

Kreinces: When the market is trending upward as strongly as it has been, we try to capture as much of that as possible. So our long-short model hasn't been in cash during the past five weeks. We're very much trying to listen to what the market is telling us. The nature of our long-short model—along with the other models—is that it doesn't try to outguess markets. We're clearly in an uptrend and that pattern hasn't broken enough to send us back to cash yet.

IU.com: You also have an overlay for your models based on your own views, don't you?

Kreinces: Yes, but that overlay is implemented only when markets are at extreme levels. Right now, our more subjective judgments are being used to override our objective, rules-based quantitative processes only to a very limited degree.

IU.com: Why is that?

Kreinces: Our goal is to follow our rules-based methodology as much as possible. But when the markets shock our models, we don't want to get whipsawed around—that's expensive. So part of our risk controls are to allow for some sort of logical override to prevent severe losses of capital. We've got limitations on our threshold for pain. If our models aren't able to keep risks within a certain range, then we'll step in. Lately, we've been overriding the models in our core alpha strategy to try to stay out of the markets.

IU.com: How defensive are you in those types of composite portfolios?

Kreinces: Right now, we're about 85% long in our core alpha model, which equal-weights the other three strategies into a single, blended portfolio. The effort to fight the current rally reflects the fact that we were down in the mid-single digits in the first quarter in the core alpha strategy. That's a big drawdown for us. So as markets started rallying, we've participated in a very conservative fashion. The core alpha strategy is down slightly for the year. So we've eaten away at the drawdown, which is giving us a progressively bigger risk appetite.

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.

Mike Englund is chief economist at Action Economics LLC. He is a specialist in Federal Reserve policies and the U.S. economy. Before joining the Boulder, Colo.-based research firm, Englund was the chief economist for MMS International. His background also includes serving as Standard & Poor's chief market economist.

On Monday, IndexUniverse.com's Murray Coleman caught up with Englund as he was assessing the latest U.S. Treasury and Federal Reserve moves to buy so-called "toxic" assets and strengthen credit flows in U.S. markets.

IndexUniverse.com (IU): Is the current stock market rally sustainable?

Mike Englund, chief economic, Action Economics LLC (Englund): In the past two months, we've seen evidence that the rate of collapse in the U.S. economy seems to be slowing. Essentially, it's coming primarily [from an uptick] on the retail side. Whether or not that translates into moderation is something we're going to have to wait to see.

IU: How does the Fed's movement toward quantitative easing figure into all of this?

Englund: If they're going to buy fixed income, that's going to drive prices higher. It's not clear whether that's a good thing for the economy as a whole. But if you're an investor trying to sell Treasuries, it's definitely a good thing.

IU: Isn't the point to try to establish a pricing floor for mortgage-backed securities?

Englund: That's part of the plan. But the Fed is also going to be buying MBS and agency debt. There is concern at the Fed that since their debt is essentially owned by taxpayers, eventually their liabilities would be the taxpayers' if these securities wound up posting a loss in value.

So they don't want to just use quantitative easing on MBS. They're hoping that by purchasing Treasuries, that should in turn raise the value of MBS and related securities.

IU: What are the other issues facing the economy?

Englund: We're waiting to see how far consumers have pulled back. The retail sales data for March, April and May are going to be important to see if the bounce we saw in January and February is sustainable or just seasonal. We're also watching to what degree employment statistics, which are a lagging indicator, keep going [down]. We're expecting unemployment to keep rising through the fourth quarter or so. But we're hoping the rate of decline in the number of jobs outstanding will slow in the second quarter.

IU: How realistic is that?

Englund: At this stage it's hard to judge. We're hoping people quit panicking. People don't run forever. But it's hard to know when the stampede will end. Right now, everyone's running with the herd. Whether those last few retail sales numbers suggest there's a let-up is anyone's guess. Our assumption is that the sales numbers will turn out to be a helpful sign going forward.

IU: Is the government's stimulus plan helping?

Englund: It's unlikely to be helping so far. The stimulus plan had a remarkably low level of stimulus in it. Much of the spending is back-loaded over a 10-year period. Even smaller still is the collection of benefits to provide more incentives for individual business owners to hire more people.

In theory, jobs will be created. But it's not going to be a short-term shot in the arm. At the same time, consumer confidence measures fell through February, which is an ominous sign. Presumably, a mass-cash giveaway by Congress should give people some level of confidence.

IU: So what does the U.S. economy have going for it?

Englund: The one big plus is that the private sector seems to be working out its problems on its own. Given enough time, the markets are going to right themselves naturally. We're assuming somewhere around midyear this recession will end. But even if that happens, it would still represent the longest post-WWII recession on record.

IU: How does the Treasury's new toxic asset plan look?

Englund: That's clearly going to be a positive for the market. The government is going to essentially round up private capital and toss some public money into the pot as well. And officials are promising that there won't be any compensation limits on executives like they've imposed on TARP. But they said the same thing at the beginning of that program as well.

IU: Do you see the new plan working then?

Englund: It's going to be a question of what type of dialogue the government has with private investors. And we'll also have to see where legislation goes that was enacted last week in the U.S. House to limit executive compensation. Those proposals have to be reconciled with the U.S. Senate. If Congress imposes a 90% tax on bonus income on those involved with the TARP program, why would participants in this new toxic asset plan believe that they wouldn't be included in the same sort of disincentive plans?

IU: What sectors do you have the most optimism about going forward?

Englund: The Auto sector's contracted pretty sharply. There may be no further room to fall from here. And if we see further agreement between policymakers in Washington, D.C., and major automakers, some stability might come to that market. The vehicle sales numbers are quite low, but at some point, people will start buying more cars.

There are probably some people with older cars looking to buy once they've got some confidence in which automakers are going to survive. We dropped in January to a 3.8-million assembly rate—which is the rate at which we assemble cars. That's a third of the normal pace. Even if we were to double that rate by the end of the year, we'd still see a relatively poor year. But there is clearly room for a nice bounce.

IU: What other sectors could bounce back in 2009?

Englund: In general, we've seen a substantial pullback in global trade. We believe export growth fell at about a 37% clip in the first quarter. If you look at imports, they fell at about a 31% rate in the first quarter. So we've seen a sharp cutback in global trade. Economies with the most exposure to global trade, particularly those in the Pacific Rim, have been hit the hardest. Many of the Asian economies fell at a 20% clip in terms of GDP growth in the fourth quarter, and might show similar declines in the first quarter of this year. But there's a limit on how much global trade can be sustainable at this point. The rate of decline has to diminish.

IU: What sectors can benefit from that?

Englund: About a fifth of our economy has some exposure to importing and/or exporting. So this could provide a widespread boost to the U.S. economy if global trade picks up. While Automakers and Real Estate are sectors we watch closely, they represent a smaller portion of the overall economy.

For example, automakers only make up between 3-4% of GDP. Meanwhile, residential construction is about 3%. Foreign trade is clearly going to be a bigger driver of economic growth in the future.

We're assuming the rate of contraction in U.S. imports and exports will decline in the second and third quarters, and perhaps resume growth in the fourth quarter. Tourism, airlines, hotels, shipping and transportation could all benefit a great deal from a resumption of more-normalized global growth patterns.

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.

Money manager sees stability growing in domestic stock markets and believes that Brazil, South Africa and Korea are undervalued.

Brad Jensen is senior portfolio manager at Accuvest Global Advisors in Walnut Creek, Calif. He also manages portfolios for a sister company, William Wright & Associates. In total, the two advisory firms manage more than $1 billion in assets mainly for high net worth and institutional investors overseas.

IndexUniverse.com's Murray Coleman caught up with Jensen to get his take on the global economic situation. The 24-year veteran portfolio manager focuses on international markets and currencies. Jensen uses exchange-traded funds to implement a majority of his stock allocation strategies.

IU: Where is developed Europe in the economic cycle right now?

Jensen: They're a little bit behind the U.S. But an eventual European recovery, in our opinion, will be more robust. However, there's still a lot of uncertainty in the market. For that reason, the U.S. has to be the one to lead the rest of the world out of this global recession.

IU: Do you see signs of that happening?

Jensen: We do see leading indicators stabilizing in the U.S. We're seeing modest thawing in credit markets. And the ISM Manufacturing index is showing that purchasing managers are picking up their activity. That has proven in the past to be a leading indicator—rather than a lagging indicator. But nobody is saying there has been a massive improvement. Again, we're just seeing very recently some form of stability in global markets.

IU: What other positive signs are you seeing?

Jensen: Another positive indicator to us is strong demand for copper. That's significant since copper is an important raw material used in manufacturing and other infrastructure-type of products. China has become such a large user of raw materials, so the rise in copper prices indicates that demand in Asia is improving. Copper prices aren't up to the levels we saw last spring, but they have showed renewed strength. We think that's big.

IU: How are you weighting global portfolios in terms of U.S. as compared to other developed markets?

Jensen: In terms of equity weightings, our U.S. allocation is around 40%. That's about six points underweight relative to the MSCI All-Country World index. In our core global portfolios, we've got another 30% devoted to Europe. That's an overweight position compared to the ACWI, which has about 25% in Europe. So even though it's a smaller allocation versus the U.S., we're still more bullish on Europe over the longer term.

IU: How do you view Japan?

Jensen: The ACWI weighting is 10.5% and we're at 8.5% right now. We're making a call on Japan in a negative sense. The fundamental data as it relates to Japan is very weak. In fact, it's the lowest-ranked country in our review of 30 major global markets. That causes us to be underweight in our core portfolios. The U.S. and Japan have been underweight in our models for several years now.

IU What's your take on emerging markets in general?

Jensen: We've been underweight those markets for awhile. Emerging markets have just been ravaged during this credit crisis, from September 2008 through today. But it has been impacted to different degrees. In general, though, these markets have been ripped. As a whole, emerging markets were down about 65% in November 2008 from its October 2007 highs. But our view is that it's an important part of the world and we dominate in exposure in our core portfolios. That said, we are totally naked in our core portfolios of some countries such as Chile, China, India, Russia, Taiwan, Turkey and Malaysia.

IU: Why are you bearish on three of the BRICs?

Jensen: The market's breakdown has hit Russia, India and China especially hard. We see all three countries as very risky at this point. The one thing that tends to go up in a down market is correlation. Avoiding risk is the one theme that has driven all asset classes throughout the world.

When we see a return to risk-taking, even at marginal levels, those tight correlations will start to at least show some interruption. At that point, the market will have more appetite for risk. That's when we'll become more interested in the BRICs, specifically, and emerging markets in a more general sense.

IU What emerging markets are you more bullish about?

Jensen: South Africa is the third-highest-ranked country in terms of our risk exposure. We use the iShares MSCI South Africa Index (NYSE: EZA) to provide exposure to that market. We evaluate South Africa, like all other countries, based on several factors.

One is that we take a close look at exchange-rate overvaluation and undervaluation levels. Another important factor we monitor is the level of political risks involved in a particular country and market. And we also look at concentration of stocks in ETFs.

Besides risk, South Africa also scores highly in terms of fundamental factors. Those include: earnings growth (both short and long term); returns on equity and a myriad of different slicing and dicing of earnings-share data. Interestingly enough, South Africa is only average in terms of valuations.

IU Are there any others?

Jensen: Although they're fairly small weightings, we're overweight Brazil and Korea. The common factor driving those two countries in our mind is an undervaluation of their currencies. I understand someone could argue that both economies are weak right now and their currencies are overvalued. But we think that they're actually undervalued, based on a number of factors we review. In general, we look at a basket of goods and how much they'd cost if purchased in the home country. Then we compare that to current market rates those currencies are bringing on world exchanges.

It's important to keep in mind that undervalued currencies in an export-heavy economy can increase GDP growth in that country significantly. That's why we think all three countries—South Africa, Brazil and Korea—have competitive trade advantages that will drive growth as world economies recover.

Credit Suisse Securities, the issuer of four Elements-branded exchange-traded notes, confirmed on Friday that it was pulling three of those funds off the New York Stock Exchange. 

Set to end trading on the NYSE by April 3 are:

• The Elements MLCX Gold Index ETN (NYSE: GOE)

• The Elements MLCX Livestock Index ETN (NYSE: LSO)

• The Elements MLCX Precious Metals Plus Index (NYSE: PMY)

A Credit Suisse spokeswoman said a release had been posted on its Web site. An earlier check by IndexUniverse.com didn't locate the news, which was anticipated due to unusual trading activity recently in many of its shares.

But late in the week, the same representative called IU.com back to say that a statement had indeed shown up on the site. It was dated March 10. 

In the release, Credit Suisse credited "insufficient" trading volumes for the decision. At the same time, Credit Suisse didn't rule out letting the trio of ETNs trade over the counter. 

It added that there's no plan at the moment to delist its fourth ETN, the Elements Credit Suisse Global Warming ETN (NYSE: GWO).

"However, there is no assurance that the GWO ETNs will continue to be listed on NYSE Arca or another securities exchange," the statement added. "In addition, from time to time Credit Suisse may decide, at its sole discretion, to issue additional units of the GWO ETNs."

At the end of February, Credit Suisse said that it had been contacted by the Securities and Exchange Commission regarding "extraordinary" trading and price movements linked to GOE.

At the same time, Credit Suisse said it didn't plan on issuing any new shares of the ETN and that there was no lead market maker on the NYSE assigned to make a market for the fund. 

On the same day, in a separate announcement, the firm said it expected to issue an additional 404,000 units of the now soon-to-be delisted LSO. "As a result, the maximum amount of securities outstanding at any given time is not expected to exceed the 654,000 securities outstanding as of February 26, 2009," the statement added.

The Credit Suisse ETNs aren't the first Elements to delist. Last October, five currency Elements also were taken off the NYSE for lack of assets—less than nine months after they had launched. Those were issued by Deutsche Bank, however.   

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

The ongoing bear market hasn't left investors many bright spots in the past two years.

But as an analysis of the Russell 3000 Index's slump shows when broken down by subsectors, some areas of the broad U.S. stock market have been hit harder than others.

Consumer Staples and Health Care have fared the best. (See related story here.)

As a result, it's not surprising that those two sectors' weightings in the market-cap-sized Russell 3000 have gone up. Since the beginning of 2007 through the end of February, both have seen their weightings go up more than 3 percentage points. (See table below.)

But Energy—which has dropped 20+ percentage points more than either Health Care or Consumer Staples from the bear's peak-to-trough—actually has gained the most of any sector in terms of sector weightings.

In fact, strip out Financials—and to a lesser degree Consumer Discretionary—and the change in weightings from a total stock market view takes a much different angle.

Only the highly cyclical Materials sector has also generated negative benchmark weightings during this period. And those lost a relatively slight 0.89 percentage points.

Then & Now: Russell 3000 Weightings By Sector

*Jan. 3, 2007-March 4, 2009

Within the next 12 months, ETFs could play a major role in helping municipal bond markets shake out, says strategist James Colby.

James Colby is Van Eck Global's senior municipal fixed-income strategist. His 28 years of experience in the industry also include serving as a muni director at Lord, Abbett; John Hancock Funds; and Evergreen Asset Management, among others.

On Friday, IndexUniverse.com's Murray Coleman caught up with Colby to discuss recent developments in muni bond markets and the role exchange-traded funds are playing.

IU: Are bond ETFs helping to set prices and improve liquidity in municipal markets?

Colby: Bond ETFs have helped to maintain, if not improve, liquidity. Muni ETFs, as a group, are only a year and a half old. They were thrust into the marketplace at a period we'll all look back upon as a seminal point in the fortunes of Wall Street. We were simultaneously hit with subprime woes and corresponding auction-rate securities problems. The demise of the single-purpose bond insurer also took place at this same time. With all of that as a backdrop, muni ETFs certainly came to market at a time of tremendous strain and tension in our capital markets.

IU: What have ETFs proven so far?

Colby: For one, they've definitely proven an ability to attract investors. That fact is supported by the asset growth we've seen in muni ETFs despite such an incredibly difficult market environment. We've gone from zero assets under management to over $2 billion in 18 months. I would call that a victory.

IU: Have muni ETFs shown any shortcomings?

Colby: What's yet to be proven is the full promise of what ETFs can deliver. They can definitely deliver improved pricing and price discovery as well as greater transparency. But it hasn't happened yet in the context of being able to transact in a reasonably efficient and orderly market.

IU: Once markets return to more normal circumstances, do you see muni ETFs helping investors in other ways?

Colby: Yes, I do. It's important to note that the muni marketplace is about $2.7 trillion in U.S. market value. At the same time, there's no exchange for munis—they're still traded as an over-the-counter asset. So transparency in terms of price discovery remains as murky as ever. With ETFs, however, a financial model has been created to price municipal bond portfolios every 15 seconds of every day that an exchange is open. That point has sort of been lost in the fog of the turmoil in the marketplace. But the model that is in place for pricing muni ETFs—as imperfect as some may view it—has indeed established a basis for specialists to make markets.

IU: How is the growth of muni ETFs impacting costs for investors?

Colby: It might cost an investor in fees and related expenses anywhere from 2-4% to purchase or sell an individual muni security. Mutual fund muni fees range anywhere between 60-120 basis points in average costs. Contrast that to the transparency and low cost of muni ETFs, which have expense ratios ranging from 16-35 basis points. So ETFs really are driving down costs for all types of investors to participate in this market.

IU: But aren't muni funds typically used only by upper-income investors?

Colby: Over the years, the perception has been that munis are for high net worth investors. In fact, for investors in the lower tax brackets, there are very attractive opportunities that might now be realized with the use of ETFs. And there are plenty of Web sites that you can use to compare the taxable equivalent of munis to taxable bonds.

IU: How does the current muni market look in that regard?

Colby: Here's an example. As of March 5, the SEC 30-day yield of the Market Vectors Intermediate Muni ETF (NYSE: ITM) was 3.87%. At a 15% tax bracket, the taxable equivalent yield would be 4.56%. In the 25% tax bracket, it would be 5.16%. At the 35% bracket, it jumps to 5.96%. The average maturity of this fund is 11 years. If you take an 11-year Treasury note, you're earning around a 3.50-3.60% yield.

IU: How about comparing corporate issues?

Colby: With corporate spreads being what they are, you're not going to get an equivalent maturity and equivalent-rated security anywhere close to that 6% tax-equivalent yield. Even at lower tax brackets, muni yields are very competitive.

IU: Fundamentally, what is the situation with state budget deficits and muni credit quality?

Colby: If there's any one overwhelming concern, it's credit quality. What Moody's and S&P are contemplating doing is re-rating some of the significant issuers in the marketplace. There may be downgrades in the offing if the government's recovery efforts to stimulate the economy don't prove effective. And we're talking about a need for those stimulus plans to positively impact state and local governments in the next six to 12 months. The hope is that money coming to the states will prevent any further erosion in their budget situations. The question is whether this stimulus package is going to be enough and whether it can happen quickly enough to help support local economies.

In February, the S&P GSCI fell 6.1%, led by Agriculture and Energy. But gold again proved to be a shining star for commodities sectors.

Although some bright spots showed up, the benchmark now has fallen eight straight months.   

In February, the widely followed S&P GSCI wound up losing 6.10%, led by the S&P GSCI Agriculture Index, which fell 8.15%.

But Energy, the biggest sector in the GSCI index, delivered the heaviest blow. That sector dropped 7.39%, according to S&P.

"Steep contango conditions in the futures market continue to hamper energy returns so far this year," said Michael McGlone, S&P's director of commodity indexing, in a statement.

So far in 2007, gold is leading the way. The S&P GSCI Precious Metals Index continues to be the strongest sector, with a return of 7.27% for the year through February. In the new year's second month, the Precious Metals index gained 1.78%.

The more economically sensitive S&P GSCI Industrial Metals Index also rallied in February, improving by 1.57% on the month.

Source: S&P

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

Gus Sauter is Vanguard Group's chief investment officer. He started at the funds giant in October 1987, two weeks before global markets crashed.

In that environment, Sauter took over as head of Vanguard's quantitative equities group, which at the time consisted of only index mutual funds. Since then, the unit has expanded to include a combination of passive and active quantitative strategies. Six years ago, Sauter assumed the company's CIO duties as well.

On Wednesday, IndexUniverse.com's Managing Editor Murray Coleman caught up with the busy Vanguard executive to discuss current market conditions and trends he's watching such as the upcoming launch of the Vanguard FTSE All-World ex-US Small-Cap Index Fund.

IU: Is buy-and-hold investing dead?

Sauter: No, I don't think it is. In fact, it's as prudent today as ever. When investors establish an asset allocation plan, they should realize there's going to be volatility in the market. So they should stick with their plan in a disciplined fashion. Realizing that volatility exists in the market now shouldn't be reason to abandon a long-term investment plan.  

IU: How do you view the relative under-performance by fundamental indexes last year?

Sauter: It's not surprising given the fact that a value and mid-cap orientation under-performed the broader market in 2008. That's the tilt you get with a fundamental weighting scheme. That was true in historical backtests and it has proven to be true in real time as well. As mid-cap value goes, so goes fundamental indexing.

IU: Why did it take so long to come out with an international small-cap index fund and corresponding ETF?

Sauter: We love a challenge, and thought it would be a great idea to launch an international small-cap fund in this environment. But seriously, we think there's a long-term investment opportunity for certain investors in international small-cap stocks. In particular, we've been trying to provide financial advisers more tools to build diversified portfolios.

There's definitely a portfolio management challenge in trying to access the small-cap international marketplace. It can be a very illiquid corner of the market. So we have to use sampling techniques, which can lead to some tracking error at times.

The other concern with an international small-cap fund was that we didn't want to offer a product based on fad appeal. We wanted this fund to be viewed as another element in a long-term-oriented portfolio, not just as a short-term timing vehicle.

And finally, we've offered several index mutual funds and ETFs through FTSE lately. It complements our FTSE All-World ex-U.S. ETF (NYSE: VEU). So it was a natural fit with that fund. (See related article here.)

IU: Unlike much of the rest of the industry, didn't Vanguard have strong inflows into ETFs as well as mutual funds in 2008?

Sauter: Yes, across the board inflows were quite positive. (See related story here.) The ETF class probably attracted a bit more assets into the hotter categories. We saw strong money flows into emerging markets. And we saw a lot of money flowing into REITs in the first half of the year before reversing course as the economic climate became more unclear. And we saw broad interest in the Total Stock Market ETF (NYSE: VTI) as well as in the mutual funds share class.

Last year was actually the second-best year in terms of cash flow into the total complex across both classes of shares of ETFs and mutual funds.

IU: Why did you add a long-short mutual fund, the Market Neutral Fund (VMNFX)?

Sauter: We thought it would be a good diversification tool for institutional and high net worth investors. Although it has been a Vanguard fund for a little over a year now, the fund itself has a history going back several years. It started out on the Schwab platform more than 10 years ago. But it didn't receive much in the way of traction, so we decided to adopt it at Vanguard.

IU: Why is that?

Sauter: We wanted to get into the long-short market-neutral space. We think it's a good diversifier for a broad-based portfolio. We'd been working on it internally for several years. But when this fund became available (it was a Laudus fund), we decided that since it had a good track record, it made sense to add it to our lineup. The external adviser is Axa Rosenberg, which remains a manager on the fund. But we've taken over 50% of the fund's management internally here. Both managers apply quantitative techniques to maintain the portfolio and to control the risks of the long and short portfolios.

IU: Where do you see quant funds compared to active funds these days?

Sauter: The distinguishing feature between quantitative methodologies and active management is that we're not using fundamental techniques such as talking to competitors and evaluating corporate management. But in quantitative modeling we're still trying to beat the market, just as with an actively managed mutual fund. We've got 15 different quant funds with a total of around $20 billion in assets. Most of them are internally managed. Over the long term, their track records have been favorable. But over the past 18 months, they've had difficulties.

IU: How so?

Sauter: A lot of hedge funds are quantitative in nature and have been deleveraging. As they've had to sell off positions, they've put pressure on the same sort of stocks many of our quant funds own. And every product has a down cycle. This is definitely one of those times for quantitative managers. We're anxiously waiting for the other side of the cycle.

IU: With stock funds undergoing their worst 10-year period on record, is the case for building portfolios around equities somewhat diminished?

Sauter: We don't think the past decade has done anything to alter the long-term case for equities. We think the reason why there's a risk premium with equities is due to periods like what we're going through these days.

IU: How about international equities, which have been hit even harder lately than domestic equities?

Sauter: Our view on U.S. versus international is one of trying to gain broader diversification. Investors should realize that diversifying into international markets helps smooth overall portfolio returns over the longer term, but only at the margin. Greater diversification can actually be gained by investing in other asset classes such as bonds.

IU: What about alternative asset classes such as commodities?

Sauter: Other diversifiers can be useful in a portfolio. Investors need to have rational expectations, though. A lot of people rushed into commodities a year ago and probably had too-high expectations about their performance. Over the long term, performance expectations for commodities would be in the 6-8% average annualized return range.

But many investors have been projecting short-term return trends—when commodities were soaring to historic levels—into their future asset allocation plans. Those were probably too high.  Nevertheless, the advantage of owning commodities and other diversifiers isn't necessarily to increase overall returns. They're useful as a means to smooth return streams.

People need to avoid irrational exuberance over alternative asset classes.

As bloggers across the Internet were talking up a potential sale of exchange-traded funds leader Barclays Global Investors, some real news was taking place at the San Francisco-based asset management giant. 

The $1.5 trillion asset manager said on Thursday it had hired longtime Citi/Smith Barney executive John Longley as its new head of national accounts in the U.S.

In that role, Normal 0 false false false EN-US X-NONE X-NONE MicrosoftInternetExplorer4 /* Style Definitions */ table.MsoNormalTable {mso-style-name:"Table Normal"; mso-tstyle-rowband-size:0; mso-tstyle-colband-size:0; mso-style-noshow:yes; mso-style-priority:99; mso-style-qformat:yes; mso-style-parent:""; mso-padding-alt:0in 5.4pt 0in 5.4pt; mso-para-margin:0in; mso-para-margin-bottom:.0001pt; mso-pagination:widow-orphan; font-size:11.0pt; font-family:"Calibri","sans-serif"; mso-ascii-font-family:Calibri; mso-ascii-theme-font:minor-latin; mso-fareast-font-family:"Times New Roman"; mso-fareast-theme-font:minor-fareast; mso-hansi-font-family:Calibri; mso-hansi-theme-font:minor-latin; mso-bidi-font-family:"Times New Roman"; mso-bidi-theme-font:minor-bidi;} Longley will set the strategic direction and lead a team to expand iShares ETF distribution through partnerships with national and regional banks and brokers, according to the company. 

Earlier in the day, a Financial Times blog came out with a report that built on speculation running through the industry that Barclays Plc was preparing to unload its asset management arm. BGI refused to comment on the rumors.

But a later Reuters report, citing an inside source, disputed that claim. And a Dow Jones piece from London also seemed to dismiss the blog item.  (See related article here.)

Although an ongoing credit crisis is creating havoc within the financial sector -- while at the same time, most ETF providers are still attracting net inflows -- parent Barclays' chief executive has been quoted recently as saying that he prized BGI's growth potential for the entire company.

Besides owning one of the world's largest asset managers with BGI's 3,000 institutional clients, Barclays also operates a leading distributor of exchange-traded notes, Barclays Capital. It serves as the investment banking arm of Barclays Bank.

But as the rumors of an emminent break-up  of the global financial institution were dying, BGI was moving to beef-up its distribution channels. Besides the iShares ETF line, the firm also oversees the LifePath target-date retirement family of funds, global long-short investment strategies for institutional investors and securities lending services, among others.

Longley has a background in distribution and customer relations management stretching back 20 years. He joined Smith Barney in 1993 and moved up from a branch to regional and divisional director for the firm. Longley has worked in the U.S. as well as abroad and last year was named chief executive of Citi's private banking operations in the U.S. and Canada. 

Last year, his responsibilities were expanded to include Citi global wealth management's domestic lending services and its capital strategies unit. 

The selection of Longley figures to reinforce BGI's strategy of moving deeper into the institutional marketplace with its ETF business. Last year, it hired the leading global researcher in the exchange-traded marketplace, Deborah Fuhr. She had been a pioneer in developing and analyzing exchange-traded investment products for Morgan Stanley's institutional clients. (See related story here.)

Normal 0 false false false EN-US X-NONE X-NONE MicrosoftInternetExplorer4 /* Style Definitions */ table.MsoNormalTable {mso-style-name:"Table Normal"; mso-tstyle-rowband-size:0; mso-tstyle-colband-size:0; mso-style-noshow:yes; mso-style-priority:99; mso-style-qformat:yes; mso-style-parent:""; mso-padding-alt:0in 5.4pt 0in 5.4pt; mso-para-margin:0in; mso-para-margin-bottom:.0001pt; mso-pagination:widow-orphan; font-size:11.0pt; font-family:"Calibri","sans-serif"; mso-ascii-font-family:Calibri; mso-ascii-theme-font:minor-latin; mso-fareast-font-family:"Times New Roman"; mso-fareast-theme-font:minor-fareast; mso-hansi-font-family:Calibri; mso-hansi-theme-font:minor-latin; mso-bidi-font-family:"Times New Roman"; mso-bidi-theme-font:minor-bidi;} "We are delighted to have someone of John’s caliber and experience join us as we continue to reinforce our leadership position in the fund industry," said Michael Latham, CEO of U.S. iShares at BGI, in a statement.

-- This article was submitted by IndexUniverse's Murray Coleman. 

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Are more teeter-totter exchange-traded funds on the way?

If approved by the Securities and Exchange Commission, they'll certainly have a bit more juice.

MacroMarkets has submitted a revised prospectus for its request to the SEC to offer two new funds.  

Much like earlier versions of MacroShares that gave investors a different sort of way to play the oil markets, the new ETFs will have an "up" and a "down" version. That has commonly been referred to as a "teeter-totter" type of approach to investing.

This time, MacroShares is targeting U.S. home prices. (See related article here.)

"The major difference we're making in the amendments is that we've gone from having each fund provide two-times leverage to three-times leverage," said Sam Masucci, MacroMarkets' chief executive.

The changes also include shortening the terms on each fund from 10-years to five-years.

The new Macros will give investors their first chance to trade or hedge home prices using ETFs. The funds will provide both inverse and leveraged exposure to home prices:

• The MacroShares Major Metro Housing Up (NYSE Arca: UMM) ETF will deliver three-times the return of the benchmark index.

• The MacroShares Major Metro Housing Down (NYSE Arca: DMM) will deliver three-times the inverse return of the index.

A date for an auction has yet to be set, says Masucci. "We anticipate the auction to be sometime in April," he said. "But that's going to be dependent on the SEC's approval of our product."

The expense ratios for each ETF is expected to be 1.25% per year. The estimated price range for the securities is between $28 and $42 per share in the 10-day auction process, according to the new filings.

-- This article was submitted by IndexUniverse's Murray Coleman. 

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Are m

While high-yield bond exchange-traded funds have proved to be popular with investors in recent years, similar options for muni investors haven't been so plentiful. The only available high-yield muni funds have been either in the closed-end marketplace or through traditional open-end mutual funds. 

But that has changed. The Market Vectors High-Yield Municipal Index ETF (NYSE Arca: HYD) was launched on Feb. 5, becoming the first of its kind in the ETF marketplace. It's expected to wind up with an annual expense ratio of 0.35%.The average high-yield muni mutual fund charges 0.63%, according to Morningstar. 

"The muni high-yield segment is very interesting and has real potential in the format of an ETF," said Harvey Hirsch, a senior vice president at Van Eck Global. "About 10% of the muni market is now represented by high-yield issues."

HYD is the fifth muni ETF now out by Van Eck Global. Its index was created by Barclays and had about 4,204 different bonds entering 2009 with a market value of $101 billion. The average coupon in the index was about 5.82% and the average duration was 8.63 years.

Perhaps more important for investors is the fact that the portfolio's yield is starting out at a quite-attractive 9.35%. By comparison, the Market Vectors Long-Term Municipal Bond ETF (NYSE Arca: MLN) has a yield of 5.71%.

"There's a significant spread now between long-term investment-grade munis and high-yield munis," said Jim Colby, senior municipal strategist and portfolio manager at Van Eck Global.

In fact, yield spreads on muni high-yield bonds are now at historically high levels compared to investment-grade munis, he added. The average spread between the two, based on long-term performances of two Barclays bond indexes, has been about 242 basis points. At the end of 2008, that differential was 636 basis points.

"There would appear to be significant opportunity for those willing to assume the added risks of investing in high-yield munis now," said Colby.

In the rolling 10-year period ending June 30, 2008, the taxable equivalent return on high-yield munis topped all other categories of munis, he added. "And high-yield led by a very wide margin," Colby noted.

High-yield munis had a difficult second half of 2008. "The auto industry, airlines and paper industries that are fairly recognizable in the corporate equities indexes are also components of high-yield indexes," said Colby.

While corporate high-yield bonds have held higher correlations to stocks in the past, that hasn't been true with muni high-yield issues, contends Van Eck.

"Investment-grade municipal bonds have far less correlation to the equity market than municipal high-yield. The corporate component of HYD is in the order of 25% to 30%," said Colby. "That should be much less than a high-yield bond fund, which likely will hold a majority of its portfolio in corporate issues."

And the commonly used term for the category, junk bonds, doesn't necessarily apply to munis, points out Colby. He notes a Moody's study showing that historical default rates on high-yield munis run about 4.3% on an annualized basis. By comparison, high-yield corporate default rates come out about 32.7%.

"Muni high-yield bonds have different characteristics than they do in the corporate world," said Colby.

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

Dan Dolan is director of wealth management strategies for Select Sector SPDRs. Previously, he spent 18 years at Merrill Lynch in a variety of research and management roles. In 2003, Dolan left Merrill to join Alps Distributors to focus on the Select Sector SPDRs operations.

On Wednesday, he discussed recent market changes and the future of sector exchange-traded funds with IndexUniverse.com Managing Editor Murray Coleman.

IU: You started 2008 with $25.9 billion in assets and finished the year with $23.2 billion. Was that a disappointment?

Dolan: We were up 521.6 million shares in 2008. That represented a 77% increase in shares outstanding. In terms of trading volume, our average for all nine Select Sector SPDRs was 260 million shares a day. That was up from 90 million in 2007 and 45 million in 2006.

IU: Most of last year's decrease in assets was related to market depreciation?

Dolan: Yes. We had a great year up until the fourth quarter. The trading volume, shares outstanding and interest in Select Sector SPDRs was all great. But our ETFs are made up of the S&P 500 stocks. And XLF is the biggest of the group, even though Financials were down 55% for the year.

IU: What changed the most for you in the past year?

Dolan: The institutional use of the products continues to evolve. Whereas most ETFs are used as mutual fund substitutes, a lot of the sector-based products are being used as stock substitutes. Many institutional investors are opting for taking a basket of stocks rather than taking the risks of using individual stocks.

IU: Will that change once markets improve?

Dolan: I'll take any improvement in the market and see. The more we see unexpected announcements by companies about hits in off-balance-sheet activities, this lack of corporate trust is going to be with us. 

IU: Are Select Sector SPDRs more of a trading tool then?

Dolan: Clearly when you have the volume of 260 million a day, some are using it as a trading vehicle. But others clearly aren't. They're trying to take advantage of some investment theme. And the short side of the market is pretty active right now as well. Trying to decide which stock to short is difficult. We have about 230 million shares outstanding on the short side right now. And we're seeing more and more of it.

IU: Should Select Sector SPDRs be considered a part of State Street Global Advisors' ETF lineup?

Dolan: Sector SPDRs are advised by SSgA. It really started with a partnership in 1998 between Merrill Lynch, State Street and the Amex. The idea came out of Merrill, where I worked. The indexes are controlled by Merrill Lynch. The assets are managed by State Street and the sales responsibility is Alps.

IU: State Street has, for example, a Telecom ETF. So from an investor's standpoint, what's the difference?

Dolan: The Sector SPDRs Trust consists of nine ETFs which divide the S&P 500 into pieces. There are no stocks in the Sector SPDRs that are outside the S&P 500. Since that time, others have introduced finer slices of the market where industries are rolled up into sectors. We only have nine sector SPDRs because the 10^th S&P sector only has nine stocks. You can't make an ETF with that small of a number. So we decided to roll those nine stocks into Technology because they have a very high correlation to each other.

IU: You've just cut expense ratios on all nine Sector SPDRs, haven't you?

Dolan: Those changes became effective on Jan. 31. When we launched them in 1998, their expense ratios were each at 65 basis points. As assets have grown, we've continued to lower expenses for everyone. Even though last year was brutal, we were able to shave fees on various administrative and marketing costs to drive expenses lower. Going from 23 to 21 basis points might not seem like much, but it represents an 8.6% reduction. On the other side, Vanguard moved its expense ratios in the sector space higher, from 22 to 25 basis points.

IU: What areas of expansion are you exploring?

Dolan: We've stuck to our main focus. And it has served us well. In December 1998, there weren't even 20 ETFs on the market. In fact, Northern Trust just announced they were going to close their 17 NETS. In the mid-1990s, Deutsche Bank launched a whole series of country-specific ETFs. And they closed within a year, if I remember correctly. So to launch nine in the late ‘90s was a significant event back then in the ETF world. And our assets have steadily grown. We had about $4 billion in assets to start 2003. Our high watermark was four months ago, when we had over $35 billion. So it has been a great ride.

IU: How do you view the competitive landscape?

Dolan: We were the first mover in sector ETFs. Then iShares came out with their series of sector products. Vanguard followed and now PowerShares has two sector ETFs. In the last couple of years, ProShares and Rydex have come out with leveraged sector products. According to a recent Morgan Stanley report, there are 152 pure sector and industry ETFs on the market now. And that's not even including the leveraged and inverse products. But we were the first and still the largest by far.  

In a move that drew mixed responses from money managers on Thursday, one investor bought an estimated $4.8 million worth of put options on shares of the SPDR Trust (NYSE: SPY).

Options houses reported that a single unknown buyer transacted 34,000 April puts on the exchange-traded fund at a strike price of $70, according to Reuters.

Traders say it's likely a hedge fund manager or other type of institutional portfolio manager with enough assets to try to game the market took advantage of an otherwise slow day for such transactions. 

"This seems like a very aggressive move. The options they went long on expire in April. So it looks like they're protecting themselves against the S&P 500 falling as much as 17% between now and then," said Paul Baiocchi, a senior market strategist at Delta Global Advisors.

The unnamed investor—or investment group—bought put options at $1.79 each on SPY. Each contract represents 100 shares. Based on the reported number of contracts purchased, Baiocchi says the deal translates into slightly less than $4.8 million in options taken on SPY.

But unlike some options traders are warning, he says the move doesn't necessarily mean the manager is making a bearish call on the broad stock market.

"It might be an outright speculator. But it seems more likely that it's a manager who's trying to protect the overall volatility of his portfolio," said Baiocchi. "He might just feel extended with his other stock picks and feel like it's time to gain some insurance, regardless of short-term conditions."

Red Flag 

A red flag, however, was trading volume on SPY on Thursday. "The volume of SPY options, especially for ones expiring by April, was very small relative to the size of this one trade," said Baiocchi.

In fact, on the day, a total of about 36,847 contracts traded hands involving April $70 SPY puts, according to Main Management in San Francisco.

"Almost 95% of the day's volume was a single print," said Kim Arthur, chief investment officer at the institutional and high net worth advisory firm.

The total outstanding contracts in SPY, or open interest, were only 4,542 before Thursday, he added. "So that boosted the SPY options contracts more than eightfold," said Arthur.

"Regardless of the strategy they're trying to employ, what this boils down to is that somebody's making a big bet that the S&P 500 will fall to the 700 range," he added, noting that the index closed on Thursday at 845.

Since the investor paid $1.79 per options contract, that means he or she won't start making money until the S&P 500 tumbles below 680.

"This isn't an extraordinarily huge bet. It just looks that way relative to the existing cumulative volume on SPY options, which has been fairly weak up to this point," said Arthur. "Basically, these contracts have only been available for eight trading days and not much has happened. So somebody's rolling out the dice and taking a shot."

Whether it was intended to be a bearish speculative move or not, Baiocchi warns that in such uncertain times, speculators could start circling the ETF even more.

"If you know there's a big buyer who wants to buy a ton of options on SPY, and there's not much other activity otherwise, you're going to start trying to write options to make money off this type of a move," he said. "The natural question for any trader is: What does this guy know? It could put pressure on SPY in the short term."

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

But I think you can still take advantage of the favorable tax treatment for as long as it lasts (which may be forever). People tell me they won't invest in ETNs because of the tax risk.  What tax risk? In the worst case, ETNs are treated the same as ETFs from a tax perspective. Currently, they're treated better.  So all you have is upside.  (Whether that upside balances the credit risk is another matter, but the tax issue is clear.)

ETNs are certainly top-of-mind right now because of the flurry of excitement surrounding the VIX ETNs. As has been discussed in many places, there are some important issues with these ETNs. 

For starters, they don't track the VIX. People really want to invest in the spot VIX, mostly because it tends to spike when the market crashes, making it a nice hedge. But these ETNs actually track VIX futures, which are very different. While VIX futures do tend to move up during times of crisis, the response is not certain, and the tendency is to produce a much smaller move than the spot VIX.

S&P has some good data on this in its white paper. On the 20 largest down days in the S&P 500 over the past 3 years, the market has fallen on average 5.5%.  Meanwhile, the spot VIX jumped 14.5% on average, while near-month VIX futures rose just 9.6%. The direction is right, but the magnitude is diminished.

Moreover, as Don Fishback explains in Murray Coleman's article on IndexUniverse.com, VIX futures moves can lag the moves in the spot VIX, creating very anomalous returns. If the market goes crazy today, the spot VIX may jump --- say from 40 to 80. But the futures don't measure the price of the VIX today; they measure it at some date out in the future. Because the VIX tends to be mean-reverting, investors might collectively believe that the VIX will settle back down to 40 before the futures expire. As a result, the futures won't budge, staying at 40.

Now, let's say the VIX spot price slowly falls from its peak of 80, trailing back down to 70 over the course of a month.  The VIX futures will have to play catch up as they approach expiration, rising from 40 to 70.  So, if you invested in the VIX futures after the initial VIX price spike, you were upside down: The VIX fell, but the value of your VIX futures rose.

Murray asked me a very good question about this: What makes VIX futures more of a problem than commodity futures in this regard? After all, we buy oil futures contracts as a way of gaining exposure to crude oil.

The answer, I think---and I'd love to hear feedback from options experts here---is two-fold.  For one, VIX prices are more volatile on an intra-day basis: You can get a quick doubling of the VIX during times of extreme crisis, while the price of oil rarely moves in such massive leaps and bounds. That creates a greater risk of this time-lag turn-around.

But the bigger issue is that VIX prices are mean-reverting whereas oil prices tend to exhibit momentum characteristics (if they exhibit any trends at all).

The VIX may spike higher (or lower) temporarily, but over time, it has a tendency to return to an "average" base state. Therefore, when the VIX spikes, the futures tend to mute or ignore that move in the short-term. The futures tend to price in some reversion-to-the-mean prior to the expiration of the future.

But if oil spikes, the market has no real reason to expect it to revert in the near-term. Therefore, the futures price will tend to track the spot price better than VIX futures tend to track the VIX itself.

Jim?  Thoughts here?

Jim Herrell considers himself a nontraditional index investor.

The chief investment officer at Partnervest Financial Group says his contrarian investing strategies take a more proactive approach to exchange-traded funds.

"We view volatility as an asset class unto itself that's negatively correlated with equity indexes," said Herrell.

The Santa Barbara, Calif.-based Partnervest manages portfolios for advisors across the country. It's part of a growing number of asset managers acting as outsourcers to independent planning firms.

Demand for such specialists is growing rapidly, according to industry statistics, as other aspects of financial planning—such as estate, health care and tax issues—are becoming more complex.

Partnervest was founded nearly seven years ago by ex-executives of a large asset manager based in Scottsdale, Ariz., that focused on serving high net worth clients and institutions in the health care industry. Herrell is a former longtime hedge fund manager.

Efficiency In An Inefficient World

"We believe markets are efficient, but traditional asset-class investing is inefficient," he said. "We're investing with the goal of achieving high absolute returns independent of the market's direction."

Before joining Partnervest last July, Herrell was a manager at Santa Barbara Quantitative Strategies for about five years. He was also a partner at Strome Investment Management, a global macro-hedge fund.

Herrell, age 42, started using ETFs with his hedging strategies in 2003. "Not only are they more flexible and transparent than mutual funds," he said, "but many ETFs have listed options."

That's important since some of the most sophisticated hedging approaches utilized by Partnervest rely heavily on options.

"Structured targeted-return strategies that used to be the purview of hedge funds and big institutions have been democratized by the rise of ETFs," said Herrell. "Now, almost any investor can access strategies similar to those used by Harvard and Yale and other large institutions in an all-ETF format."

An approach that simply invests in long positions with ETFs is just too risky in his view. "One bad year's worth of volatility can destroy several years' worth of accumulated returns," said Herrell. "No matter how you slice and dice it, traditional asset class investing provides way too much risk for the amount of return it can provide."

Partnervest's managers say they don't try to predict market movements. "The only predictive element in our strategy is that volatility is a constant," said Herrell.  "And our portfolios are built to take advantage of that uncertainty."

The firm employs a mix of strategies using ETFs. The simplest tries to maximize alpha. For example, the firm uses the SPDR S&P 500 (NYSE: SPY). Herrell says the ETF is added into the mix with the expectation that its underlying index will show long-term volatility of at least 20% a year.

In the firm's alpha strategy, that range is split in half to target 10% price movements in any given six-month period. "Instead of buying SPY, we structure an options call spread on the ETF at current prices," said Herrell.

The process involves taking advantage of gains made from initial strike prices on those option calls. (A strike price is simply the point at which an investor is going to start making profits. If SPY is selling for $85 per share, for example, and someone buys a call option on the ETF at that level, then an investor makes money on any price gains.)

"It's like leasing an ETF for a certain period," said Herrell.

While it still provides upside participation, using call spreads reduces downside risk, he says, "because you're risking fewer dollars since the cost of the options is much less than buying the ETF itself."

Herrell adds that even in a worst-case scenario, "the most you can lose is the cost of the spread" using such a strategy.

The firm also sells short-dated options. In terms of buying activity, Herrell sticks to purchasing only longer-dated options.

Self-Funding Approach 

"Even if the market doesn't go anywhere, the shorter-term options expire, and you'll make at least a little money," said Herrell. "The net result is that as time passes, this sort of time-decay pays for the upside participation. So it's a self-funding approach which limits your downside but participates in a market advance."

The other aspect of his portfolio strategy actually involves purchasing shares of ETFs outright. Currently, besides owning SPY, some of Partnervest's portfolios include: iShares Russell 2000 Index (NYSE Arca: IWM); iShares MSCI EAFE Index (NYSE: EFA); iShares MSCI Emerging Markets Index (NYSE: EEM) and iShares Dow Jones U.S. Real Estate (NYSE: IYR).

Owning actual shares of the ETFs is part of his Volatility Enhanced Global Appreciation strategy, or VEGA. In such a portfolio, Herrell will also sell call options on a portion of those ETFs to lock in returns.

"We're swapping a potential return for a fixed return," he said.

Partnervest has developed algorithms and built its own quantitative modeling system for constructing portfolios along those lines.

"It tells us how much of an ETF to buy and when to buy and sell options and at what prices," said Herrell. "Rather than guess, we have the model that dynamically adjusts to changing market conditions based on historical volatility patterns and returns."

-- This article was submitted by IU.com's Murray Coleman.

George Hoguet is a global investment senior strategist specializing in emerging markets at State Street Global Advisors. Prior to joining the firm in 1998, he worked in London and Boston with Baring Asset Management. Hoguet has also worked at the Frank Russell Co., where he consulted with large institutional investors.

IU: What do the major emerging market indexes show about volatility levels now?

Hoguet: Emerging markets have been and will continue to be much more volatile than developed markets. However, if you look at emerging markets in a portfolio, a modest allocation amount can help reduce overall risks since they're not perfectly correlated with developed markets.

IU: Do you think emerging markets noncorrelation qualities will return?

Hoguet: In the intermediate term—over the next five years or so—correlations are likely to increase. In the very long term, China will become less correlated, as will much of the rest of emerging markets. In about eight or nine years, China should surpass Japan as the second-largest economy in the world.

IU: Then for long-term-oriented investors, you're still bullish on emerging markets?

Hoguet: Investors should have a strategic allocation to emerging markets, which represent about 9% of the world's float-adjusted equity capitalization. Currently, emerging markets face substantial headwinds. But the MSCI Emerging Markets Index has significantly outperformed the MSCI World Index over the past seven years. And for the 18 years ending Aug. 30, 2008, the MSCI Emerging Markets Index had outperformed the S&P 500 by more than 76 basis points per year.

IU: Over longer periods, hasn't the U.S. in particular outperformed?

Hoguet: That's true if you go back to the turn of the 20^th century, because of the disruption of World War I and World War II. Also, the confiscation of assets by communist regimes meant that people lost everything and stock markets were closed in some countries. The point is, when you talk about the U.S. having above-average returns, that relates to the fact that in the 20^th century, we've never had a period where assets were confiscated on a large scale and markets were closed indefinitely.

IU: Then how do you measure the U.S. stock market versus the world?

Hoguet: There are a lot of methodology issues such as survivorship bias. Many companies have gone bankrupt. But what you can say is that the U.S. has been characterized by a relatively high degree of political, economic and social stability.

IU: As an investable theme, what does this mean?

Hoguet: The reason the U.S. represents roughly 45% of the world's market capitalization and emerging markets about 9% is precisely because of the political and economic risks involved in emerging markets. So the question with investing in emerging markets is whether that risk is being properly priced. And the question is over the long term, how much should emerging markets outperform developed markets?

IU: What are some of the short-term negatives?

Hoguet: Those would include the reality of a global recession. They'd also include increased financing costs and credit contraction in global markets. Investors are still deleveraging across the world and are much more risk-averse these days. Commodity prices are declining and, in some cases, countries are facing prospects for continued currency weakness. Then there's the contagion factor, which means a sell-off in one market could lead to a sell-off in other markets.

IU: Don't all markets face these same problems in varying degrees?

Hoguet: Yes, but it's a very broad dispersion. Some countries are much more dependent on commodities and natural resources, for example. China, with its large foreign exchange reserves, is in a better relative position than a country like Turkey. It runs a substantial current accounts deficit and its corporations are major borrowers on external markets. So if they can't obtain financing or if so, on unfavorable terms, they could face rollover risk. But those are just two examples. It can vary from country to country a lot.

IU: So you think correlations tightening between emerging and developed markets is a short-term occurrence?

Hoguet: I wouldn't put it that way. There are two trends at work. The first is a secular, long-term trend which is based on the fact that in general, investors are holding more diversified portfolios. That's reducing home biases, and emerging market companies are becoming more integrated into the world. The second factor is cyclical. We're seeing a deleveraging take place and a shock in the U.S. that led to a significant drop in the U.S. stock market last year. Investors have been lowering their risks and selling emerging markets. In the current environment, these two factors have led to increased correlations.

What I'm trying to suggest is that in the very long term, as China becomes the second-largest economy in the world, global business cycles won't be as synchronized. Right now, we've got a synchronized slowdown in markets across the world. That's forcing correlations to become much tighter.

IU: This year, what trends do you see?

Hoguet: The returns are extremely tied to progress in the world economies. For emerging markets to rally on a sustained basis, investors need to see significant progress towards normalization in credit markets. Right now, we're still on a downward path, as growth continues to disappoint. Investors will have to also see a reduction in volatility.

IU: How can individual investors monitor those factors?

Hoguet: What they should look at is volatility in developed equity markets, which likely will have to fall before anything happens in emerging markets. The consensus is that the U.S. economy will start to recover by the third quarter of 2009. But risks are to the downside. And there's a question mark to the path this year of the Chinese economy.

IU: What challenges does China face in coming quarters?

Hoguet: The question is how much growth will slow in China and how much its exports to the U.S. and the rest of the world will be offset by domestic demand. Chinese GDP growth below 6% would signal a sharp enough slowdown to further reduce the world's rate of growth. My feeling is that by the end of the year, emerging markets are likely to finish higher. My reasoning is that credit markets will have stabilized and improved enough to support growth and that the world economy will no longer be on a downward path.

With a week to go after the close of trading on Friday, the performance of exchange-traded funds in nightmarish markets promises to leave 2008 as one of the most unusual years on record.

Even if stocks rally in coming days, the Christmas break typically leads to sluggish volume. And it'll take a massive turnaround to usurp the ProShares UltraShort Semiconductor ETF (NYSE: SSG) from its lead as the year's top-performing ETF. 

Even with a total return of nearly 119% so far heading into Monday, SSG could be overtaken by second-place ProShares UltraShort Russell MidCap Growth ETF (NYSE: SDK). But it would take an enormous rally, though—SDK is up almost 105%. 

Following closely behind are three other ProShares ultra funds. 

"If the rest of the market has its way, this year will prove to be a flash in the pan. Few long-term-oriented investors are served by short-bias strategies. But it sure has looked smart recently," said Jeff Tjornehoj, a Lipper analyst. 

The research firm compiles indexes composed of funds for 65 different equity and fixed-income categories. The top performer through Thursday was the Lipper Intermediate U.S. Government Index, which was up 9.9% in 2008. By contrast, an index of longer-term U.S. government bond funds—including agencies as well as Treasuries—had gained 6.09% on the year. 

At the same time, the Lipper short-term government bond funds index was up 3.28%. 

All of the firm's equity indexes were negative. The worst performer was the Lipper Emerging Markets Funds Index, down 54.3% on the year. 

Lipper doesn't benchmark bear market funds performance. 

An Urge To Surge... 

In recent weeks, long-duration ETFs focusing on Treasuries and high-quality corporates have been surging. The Vanguard Extended Duration Treasury Index ETF (NYSE: EDV), for example, is No. 11 in terms of top performers on the year, according to Morningstar data.

In fact, the top 10 are all non-UltraShort ProShares. In the top 20, EDV is the long non-shorting ETF. 

The only other type of fund to crack the shorts' grip this year has been the CurrencyShares Japanese Yen Trust ETF (NYSE: FXY). That heads into the final week of the year at No. 33 with a better-than 24% return. 

But following close behind is the PowerShares 1-30 Year Laddered Treasury ETF (NYSE: PLW). Also with gains of 20%-plus are the iShares Barclays 10-20 Year Treasury Bond (NYSE: TLH). The iShares Barclays 7-10 Year Treasury Bond (NYSE: IEF) has also been hovering around 20% in recent weeks.  

"The reason why bond ETFs of higher quality have been doing better is very simple—a flight to quality," said Jim Colby, senior municipal strategist for fixed-income at Van Eck Global.

But within the past few weeks, he adds, longer-duration bond funds have found particularly smooth sailing. "We've hit a pretty dramatic period in the past two weeks of falling yields and rising prices with long-term bond ETFs holding the highest-quality issues," said Colby. 

He credits that to an announcement by Federal Reserve Chairman Ben Bernanke that it will start directly buying bonds to help drive liquidity in frozen credit markets. 

Traders are speculating that long Treasuries will be the prime target of the Fed's purchases, says Colby.

How big of a year-end boost is that providing for longer-term bond funds? For example, 30-year Treasury notes were yielding 2.55% on Friday. That compared to 3.43% at the end of November, equal to about a 20-point surge in long-bond prices, says Colby. 

"That's a huge move in the world of bonds," he added. 

-- This article was submitted by IndexUniverse Managing Editor Murray Coleman. 

John Derrick is research director of U.S. Global Investors, an asset manager which focuses in natural resources, emerging markets and global infrastructure sectors. In addition, he is a co-manager of several of the firm's stock mutual funds.

Derrick has been an analyst and portfolio manager for more than a decade. He spoke with IndexUniverse's Murray Coleman recently about the current situation in the natural resources marketplace.

IU: Do you think we're in a temporary dislocation in oil markets now?

Derrick: We're probably in somewhat of a temporary dislocation. Oil prices were unsustainable at $147 a barrel. At the same time, they're probably unsustainable at less than $42 a barrel right now. The cash cost of production, particularly for smaller producers, is probably around $45 a barrel. That's basically what it costs to pull crude out of the ground. At the same time, we keep seeing drilling rigs taken off the market. It's just not profitable to produce at these levels. Supply is going to be curtailed pretty quickly at these levels.

So we see a range of around $45 a barrel as providing a current floor for the market. The flip side is that we're obviously in a pretty severe global recession. The unemployment figures out today showed the economy lost 533,000 non-agriculture jobs in November. That's the second-largest monthly decline on record. Obviously, global demand for oil will be impacted. But as the economy recovers, oil prices are going to be an indicator of improving conditions. In this case, we think oil prices will move with the economy rather than serving as a leading indicator.

The fact that we've already been in a recession for about a year now indicates that we're maybe two-thirds through this cycle. In the mid-1970s and early 1980s, we had recessions that lasted as long as 16 months. Then if you layer on the massive policy responses we've seen from central banks and governments around the world, we think that a recovery will start to form within the first half of 2009.

IU: What's your take on the alternative energy market with a new president coming into the White House?

Derrick: It's incrementally a positive development. The biggest headwind for alternative energy is simply general pricing levels right now. Natural gas is trading below $6 this morning and coal prices are falling on the drop in demand for power. It makes sense that alternative energy will be impacted by falling demand in traditional oil markets.

But we feel like it's simply a delay in the implementation of alternative energy technologies and a short-term setback for the space's longer-term growth prospects. There is certainly a lot more political support for alternative energy. So we see delays only impacting projects over a 12- to 18-month period. After that, alternative energy looks, to us, like a promising space over the longer term.

IU: Where do emerging markets fit into commodities supply-and-demand dynamics?

Derrick: Obviously, they're very important. That's why we're confident that commodities will rebound in the future. Emerging markets demand is driving commodities as a whole. China has actually developed a middle-class, and incomes continue to rise. The key is that consumers in China aren't going to go backwards and stop buying refrigerators and air conditioners in their homes. Emerging markets have some of the best balance sheets in the world - either from an individual consumer or country standpoint. Certainly emerging markets are impacted by exports and other external factors. But they've got higher individual savings rates than those in developed markets. So we're going to continue to see consumption growth in emerging markets despite short-term disruptions in world credit markets.

We see China in particular as a major driver. Roughly 20 million people per year are moving from rural western China into more urban eastern cities. This is a trend that isn't going to fall off a cliff anytime soon. It's a long-term migration pattern that's being supported by government infrastructure spending. That's going to keep China moving forward, despite any global financial crisis now going on.

The whole infrastructure story in China and across emerging markets will drive commodity prices up over the long term. We think that China is one of the most attractive regions of the world right now. That market was one of the first to suffer massive stock pricing declines. So it's likely to be one of the first to rebound as the global economy comes out of this credit meltdown cycle.

IU: Are we facing massive inflation, a bout of deflation or something else?

Derrick: Commodity prices have fallen and continue to fall. That has been a key driver in price declines we've seen in the general market. But we believe this is more of a slow-growth period. Deflation is probably too strong of a term. We're probably in more of a disinflationary mode as opposed to an outright period of deflation.

In fact, we believe that in 12 to 18 months, what everyone's going to be talking about is rapidly increasing inflationary pressures. The amount of money being thrown at this current financial crisis is unprecedented. That will probably sow the seeds for fairly strong inflationary patterns going forward. Globally, something like $10 trillion has been pledged by governments around the world to fight this crisis. Once we get through the worst of it, someone's going to have to start paying those bills.

As a result, the chief investment officer at Seattle-based Empirical Wealth Management says that the high net-worth and institutional clients he works with aren't ready to panic yet.  

But he credits such realistic expectations to not only this year's educational push. Smith explains that he has been sounding a similar theme when markets were running strong from 2003 through late last year. The difference, he says, is that during bull markets the message has been to not chase asset classes that are performing well. 

Now, conditions are different. But the veteran advisor and portfolio managers says keeping a level head and remaining unemotional as market volatility remains high is as important as ever. Through good times and bad, he and his co-managers at Empirical emphasize that they stick to the same process of monitoring asset class correlations and watching trends in global market capitalization sizes.

And with most segments of equities pummeled this year, Smith believes that investors who've been disciplined about rebalancing their portfolios according to a long-term asset allocation plan can find plenty of good buying opportunities right now.

"The valuations right now in some areas of the market are very reasonable," said Smith. "Earnings could drop and valuations could change. But we're encouraging our long-term orients clients, especially the younger ones, to use these current market conditions to raise their stock allocations back to proper levels."

In fact, Smith says he has been scrambling to come up with extra money to put into stock funds for the portfolios of his daughters.

"Even for investors with shorter investment horizons, conditions right now offer a good buying opportunity in stocks," he said. "We're not telling older investors closer to retirement to go overboard and load-up on stock funds. But unless their circumstances and goals have changed, we think it's a good time for people to rebalance portfolios at attractive valuations."  

The firm's average allocation for his 500-plus clients is around 60% equities right now, says Smith. He prefers exchange-traded funds and passively managed portfolios from Dimensional Fund Advisors. A typical investor at Empirical might have 35% to U.S. large-cap funds. That's down from about 45% a few years ago.

In large blend categories, Smith likes the Vanguard Large Cap ETF (NYSE: VV).  He also tilts to the DFA U.S. Large Cap Value Fund (DFLVX).

The advisor targets another 20% to U.S. small-cap funds, which is relatively consistent with allocations of past years. That's divided across micro-caps, small-cap blend funds and small-cap value funds. Smith uses the iShares Russell Microcap Index (NYSE: IWC) and the Vanguard Small Cap Value ETF (NYSE: VBR) to fill those shoes. Smith also likes to include the Vanguard Small Cap ETF (NYSE: VB) and the DFA U.S. Small Cap Fund (DFSTX).

Some 25% of client stock assets now go into developed international markets. "In 2003, it started at around 16% and gradually has been bumped up," said Smith.

He uses four different funds in those areas. One of this is the Vanguard Europe Pacific ETF (NYSE: VEA) for large-blend international markets. The advisement firm mixes that with the DFA International Value Fund (DFIVX). For exposure to smaller foreign stocks, it's implementing in portfolios the DFA International Small Company Fund (DFISX) and the DFA International Small Cap Value Fund (DISVX).

In emerging markets, Smith will add about 10% of a typical client's stock assets into the DFA Emerging Markets Core Equity Fund (DFCEX). He also likes the Vanguard Emerging Markets Stock ETF (NYSE: VWO) for some portfolios.

"In early 2005, we started bumping up emerging markets allocations from around 4%," said Smith. "But emerging markets got up to about 12% of world markets based on capitalization levels at the beginning of this year. The year before it was close to 7%."

He added:  "We'll be evaluating that asset class again at year-end to see if it needs more adjusting based on global capitalization rates, correlations and valuations."

Smith is also putting his clients into the Northern Global Rest Estate Index Fund (NGREX). On average, client portfolios will have about 5% of its stock assets in that fund, according to Smith.

"It's just a straight index mutual fund," he added. "It came out about two years ago and was the first passively managed index fund that provided exposure to global REITs. It holds both U.S. and international real estate companies."

Finally on the equity side, Smith puts about 5% of an average client's assets into the iShares S&P GSCI Commodity-Indexed Trust (NYSE: GSG). "We like the exchange-traded notes in the commodities area," he said. "But until there's a ruling that changes the tax structure of commodities ETNs, we're sticking to the ETFs. And we also don't want to take on the credit risks with ETNs right now."

Empirical is rebalancing client assets into both stocks and commodities now. "But we're not big fans of buying into big pools of gold or metals. We don't focus on any one sector - we want exposure to a broad range of commodities," said Smith.

And the GSG's index weights commodities based on global production, he adds, "which is the most straight-forward and pure weighting methodology among commodities ETFs and ETNs."

Empirical rebalances portfolios based on a banding system. If an asset class shifts anywhere from 10% to 25% off its target allocation, then Smith and his team will consider making changes. Each asset class and fund is given different bands within a portfolio, he says.

"We're not market timers. But we review valuations for every asset class. So we do make adjustments, but it's not based on macroeconomics. It's based on changing correlations and valuations of different asset classes over longer periods of time," said Smith.

For bonds, Empirical focuses on constructing portfolios that are as non-correlated to stocks with as little risk as possible. "We keep it very simple using shorter-term durations and very high-quality funds," said Smith.

Empirical has four basic ETFs it includes in client portfolios. Those include the iShares Lehman 1-3 Year Treasury Bond Index (NYSE: SHY) and the iShares 3-7 Year treasury Bond Index (NYSE: IEI). The other two are the iShares 1-3 Year Credit Bond Index (NYSE: CSJ) and the iShares TIPS Bond Index (NYSE: TIP).

The firm's investment policy committee has just changed allocations within fixed-income because of narrowing spreads between TIPs and nominal Treasuries, says Smith.

It's now allocating about 30% into TIP, up from 20% a month ago. Targets for the other three are: SHY (20%); IEI (15%) and CSJ (35%).

"We want the average duration of portfolios to be around five years or less. If you have a greater number of longer-termed bonds in a portfolio, correlations with stocks go up. And the longer the maturity of bonds, the greater the interest rate risks. So we find that five years or less poses the best risk-reward profile," said Smith.

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

At least, over the long term.

Let's start with John Bogle. (Doesn't it always start with John Bogle?)

Judging by the series of interviews he's been giving lately, Bogle is very worried about the U.S. economy. As he said in an interview with Forbes today (highlighted by Murray Coleman in our invaluable new daily news roundup), "it will be a year-and-a-half to two years before [the U.S. economy] turns upward."

That doesn't mean investors should be sitting on the sidelines. Far from it. Bogle says the market may be undervalued by about $7.5 trillion right now, and thinks that the market has likely over-discounted the impending recession.

Bogle's not alone. In the forthcoming January/February issue of the Journal of Indexes, Rick Ferri (a great financial advisor) calls this "the greatest opportunity in our lifetime" for young and middle-age Americans to "set [them]selves up for retirement." Buy now, he says, and in 10 years you will be very happy.

David Kotok of Cumberland Advisors is even more bullish, saying markets could "gap" higher in 2009, and warning that investors who aren't in now will find themselves chasing a market that may have already moved much higher.

The list goes on: Wharton professor and WisdomTree advisor Jeremy Siegel thinks stocks are "dead cheap"; Larry Swedroe thinks stocks will recover; even PIMCO's Bill Gross is turning positive.

What separates all these analysts from the parade of negative voices filling CNBC, TheStreet.com and similar properties is that they are focused on the long haul. And from that perspective, understanding the market is easy.

I have no idea where the market will be three or six months from now. But 10 years from now, do you really think the Dow will be trading at 8,000? I sure don't.

Here's a thought: About a year ago, when the Dow was trading at 12,500, I bet our executive vice president Don Friedman $100 that the Dow would fall below 10,000 before it hit 15,000; in other words, that it would fall 2,500 points before it rose 2,500. I was worried by the failure of Bear Stearns and what it meant for the economy.

Right now, I'd make a similar bet, but on the upside. I'd bet $100 that the Dow will hit 10,000 before it hits 6,000; in other words, that it will rise 2,000 points before it falls 2,000.

How many people would take the opposite side of that bet?

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Noah Hamman is chief executive officer of AdvisorShares Investments LLC, a Washington, D.C.-based exchange-traded funds provider. Before starting the firm in late 2006, he was vice president of business development at Rydex Investments.

The start-up company recently sold a 60% stake to Fund.com, a New York-based over-the-counter public asset manager and educational content provider. It trades with the ticker symbol of FNDM. IndexUniverse's Managing Editor Murray Coleman recently caught up with Hamman to discuss events surrounding his company and active ETFs.

IndexUniverse: Why did you sell a majority interest in AdvisorShares?

Hamman: There were two reasons. One was to find a financial partner for the business. Fund.com is also relatively new, but they're very well-financed. The second part was about trying to work with someone who can integrate our business model and create a strong fit for both.

IU: AdvisorShares is strictly an actively managed ETF provider, isn't it?

Hamman: Yes, and we've got two ETFs currently under registration at the moment. One is designed to rotate around different sectors in the marketplace, depending on a specific subadvisor's style and methodology. The second one is a country rotation fund, which will shift between emerging and developed markets around the world—including the U.S. So it's a truly global ETF strategy. And each can use other underlying ETFs, so each will be an ETF-of-ETFs.  But we expect to register more products that will employ a number of different strategies, both in terms of ETFs-of-ETFs as well as more traditional ETFs comprised of different stocks. Our plan is to work with a broad range of subadvisors. A single ETF could have multiple subadvisors with an overlay manager around it.

IU: How close are you to getting a green light for these from the Securities and Exchange Commission?

Hamman: I would assume we're close. We've been in line for awhile, and from my days at Rydex, I certainly understand that it isn't always a quick process. But I do believe we're within a week or two of getting it, based on the feedback we're receiving from the SEC.

IU: These first two ETFs are built as retail strategies, aren't they?

Hamman:  Yes, but we plan in the future to launch hedging-like strategies and more sophisticated types of ETFs that will attract some institutional interest.

IU: Will these be truly actively managed?

Hamman: Yes, and I say that because there's nothing in our exemptive relief that limits how much our subadvisors can trade. So we don't want to change how a manager normally conducts transactions. We plan on working with existing mutual fund managers as well as emerging managers in separate accounts or other types of portfolios. In fact, we expect to work with some hedge fund managers at some point. These ETFs won't be a whole lot different than existing actively managed fund strategies found in other investment vehicles.

IU: How will your ETFs deal with transparency issues?

Hamman: They'll be fully transparent on a daily basis. The portfolio manager will make trades on a daily basis and then the fund will disclose those trades before the opening of the next day's session.

IU: Doesn't that lend itself to somewhat stale data?

Hamman: That's a very good question. We plan to incorporate a patent-pending process that improves the ability for our ETFs to trade at a more efficient price. If we get approval, that might open up our ETFs to providing even more timely transparency—in other words, sometime before the end of each trading day. But our exemptive relief request is designed to proceed whether the patent is approved or not. So we could conceivably operate just like any existing actively managed ETF.  We think that providing more information to specialists and market makers can only help make a more efficient market that will keep bid/ask spreads tight.

IU: But aren't active managers wary of providing timely information on a daily basis?

Hamman: It's true, and some subadvisors out there won't find such a prospect appealing. For example, when illiquid markets like micro-caps are involved, transparency issues might be more of a concern to some managers. In general, though, we think that most investors aren't going to find it appealing to log on to a computer and track a portfolio that closely. We think there are fund managers who agree with us and don't see transparency as a competitive disadvantage. They see transparency as more of a positive than as more of a negative. 

IU: How do transparency issues work with active mutual fund managers in actively managed ETFs?

Hamman: The managers who are going to be the most concerned about transparency issues probably will turn out to be very active traders rather than investors. And again, they're more likely to be people who work in more illiquid parts of the market. Practically speaking, I don't think creating good, smart, actively managed ETFs precludes finding the best investment managers.

IU: What does Fund.com plan to do going forward?

Hamman: Their expansion plan is to make more strategic investments in asset managers and platforms, both in ETFs as well as mutual funds. Their focus also includes hedge funds, variable insurance funds and any sort of pooled investment. Besides those activities, Fund.com plans to create original content and provide expert third-party content for investors. They want to be able to do this as an investment community and bring a social networking aspect to their Web site. Their focus is that individual investors are under-served in terms of advice. So they want to be able to take data and wrap it into high-quality advisory content.

As Murray points out, the Claymore/MAC Global Solar Energy ETF (NYSE: TAN) is up 55% over the past five days, and other alternative energy funds are rallying too. The First Trust ISE Global Wind Portfolio (FAN) is up 30% over the past week, and the PowerShares Global Clean Energy ETF (PBD) is up nearly as much, all on expectations that Obama will funnel money into the alternative energy build-out.

I've had a few people ask me why these stocks would bounce now, when Obama has been building his lead in the polls for some time now.  It's a way of suggesting that the bounce will necessarily be short-lived; a temporary euphoria before the inevitable crash.

That may be true. But remember that just six weeks ago, Obama wasn't looking so hot in the polls. In mid-September, you could by InTrade futures on an Obama victory for less than $0.50 (each contract pays $1 if Obama wins). Now, those same futures trade for $0.93, suggesting an Obama presidency is a near lock in the minds of investors.

I guess we'll find out in a few hours.

Notes On Our Commodities Conference

Jim, you did a good job summarizing the takeaways from our commodities conference. But I think you left out two key suggestions: 1) Build a bunker; 2) Stock canned food.

The best play on the coming economic crisis may be Campbells Soup (NYSE: CPB)---which, by the way, is trading near a 52-week high.

I'm mostly kidding, of course, but there were a lot of smart people and a lot of great discussion about what's happening in the U.S. economy, and none of it was pretty.

For my money, that was the highest conviction conference I've ever attended. By that I mean, I think every single person who attended that conference yesterday is looking closely at commodities today. I suspect the majority of attendees will either start or increase their allocations to commodities as a result. 

I know, for instance, that I was very happy at the end of that conference that I included commodities in my 13.65 basis point portfolio. Could I make a larger allocation? Possibly. But I sure am glad I have something in there.

BTW: One clarification for conference attendees. During the Industrial Metals panel, both of the speakers identified Tin as the single most attractive industrial metal right now. There was then some discussion about whether or not there was a way for retail investors to actually access tin.

It turns out, there is: the iPath DJ-AIG Tin ETN (NYSEArca: JJT) provides exposure to tin in an exchange-traded note format. It trades infrequently, an investors should use limit order to buy and sell, but it can be done.  

Ed McRedmond is the senior vice president of portfolio strategies at Invesco PowerShares. He joined the exchange-traded funds provider in 2005 after working for 17 years at A.G. Edwards, where he was associate vice president. While at A.G. Edwards, McRedmond served as a senior analyst covering ETFs and closed-end funds and was part of the team that launched and managed A.G. Edwards' discretionary ETF wrap portfolios.

Earlier this week, IU.com Managing Editor Murray Coleman caught up with McRedmond to find out the reasons behind PowerShares' recent plan to cut fees on its fundamentally based ETFs, as well as developments with other products. (See related story here about the changes to the funds, which are maintained and designed with FTSE Group and Research Affiliates.)

IU: Why did PowerShares decide to cut expense ratios on the fundamental-based ETFs now?

McRedmond: The main reason is that the fundamentally weighted indexes have been positioned as alternatives to traditional market-cap-weighted indexes. The RAFI [Research Affiliates Fundamental Indexation] indexes reconstitute and rebalance once a year. That's different than our quantitatively based Intellidex-based ETFs, for example. Those indexes rebalance on a quarterly basis. So in an Intellidex-based ETF, you have a lot more going on in terms of the seeking-alpha methodologies. The FTSE RAFI indexes have very low turnover, which provides somewhat fewer costs involved in managing those ETFs. And we definitely want to be competitive in the marketplace with lower-turnover types of funds, such as the more-traditional market-cap-weighted indexes—although they still offer a different methodology.

IU: Why were they originally priced at 60 basis points if they're competing against lower-cost market-cap-weighted indexes?

McRedmond: Any time you're bringing out a new product in a dynamic marketplace, you can't always be perfectly sure about how quickly or effectively it's going to attract new investors and assets. And you don't always know the total start-up costs when starting out. But it's not a question of whether the fundamental rating methodology doesn't add value over time compared to a market-cap-weighted ETF. If you look at the historical backtested data, they have added value versus a passive, cap-weighted benchmark over the long term. We're certainly not trying to be simply the low-cost provider. All of our products follow a theme of bringing to market a value-added type of portfolio.

IU: The fundamental indexes have had a tough time the past 12 months, haven't they?

McRedmond: Certainly earlier in the year and part of last, that was the case. I think the timing of the most recent RAFI rebalancing in March is a key. Remember that late last February and early March 2007 is when financials went through a particularly tough period when financials were hit hard. But contrast that with what's going on now. During the recent downturn that we've been undergoing in the last few months, the fundamental-based ETFs have made up a lot of ground as compared to traditional market-cap-weighted benchmarked funds. But it's also important to note that the earlier performance trend has been a phenomenon we've seen only in U.S. portfolios. Internationally, the RAFI indexes have actually outperformed over the last 12 months.

IU: The RAFI ETFs still haven't attracted a lot of assets yet, have they?

McRedmond: On a relative basis compared to new products and their typical evolution, the acceptance has been pretty good. That's particularly true in the flagship ETF, the PowerShares FTSE RAFI US 1000 Portfolio (NYSE: PRF). That's also true with the other broad-based fundamental ETF, the PowerShares FTSE RAFI US 1500 Small-Mid Portfolio (NasdaqGM: PRFZ). But the sector-related products certainly don't have as broad of an audience. Those are intended to be a tool for people using sectors to build broader portfolios.

IU: How have the enhanced indexes branded as the dynamic line using Intellidex methodologies been doing lately?

McRedmond: Some are performing particularly well and others are having more-challenging times. The standouts are the ones related to financials, particularly the PowerShares Dynamic Banking Portfolio (AMEX: PJB) and the PowerShares Dynamic Insurance Portfolio (AMEX: PIC). They've either had very little, or in some cases, completely avoided names that've been in the headlines in recent months. And that's what we'd hope from an ETF with an underlying index that has a methodology taking into account a variety of factors. As you probably recall, Dynamic Portfolios use quantitative systems to consider different types of risk, momentum and valuation factors to rank stocks. There are a total of 25 different factors involved in the process. By taking the universe of stocks and not owning every single one—and again, by using a quantitative methodology to screen by a number of fundamental and technical factors—you'd expect a lot more opportunities to remove stocks that are running into difficulties. And rebalancing and reconstituting portfolios on a quarterly basis provides more opportunities to make adjustments than a traditional market-cap-weighted index that rebalances and reconstitutes once a year.

IU: Invesco is launching a mutual fund using different PowerShares ETFs. Do you see more cross-marketing opportunities to work together in the future?

McRedmond: It's something we've been doing on a number of fronts, both on the sales and marketing side as well as the investment and product development side. Two of our actively managed ETFs are being subadvised by Invesco managers. That's something we definitely intend to continue to look at since Invesco has a great number of resources. They've certainly got an enormous amount of investment talent to leverage for our ETFs. While PowerShares has its own sales force, we're also leveraging off our counterparts on the Invesco side.

The value of disciplined, low-cost and highly diversified investing is really paying dividends for Lorne Abramson these days.

Despite turbulent times in the markets, the Burlingame, Calif.-based portfolio manager says he's finding his high net worth and institutional clients "shaken but not stirred."

"They're not jumping ship. And actually, we're seeing a lot more unhappy investors questioning their advisors' active strategies contacting us," said Abramson.

Along with his wife, Elana Lieberman, he runs ELM Advisors near San Francisco. Both are staunch supporters of passive asset-class investing. And each started in finance as stock analysts at institutional research and money management shops. Abramson primarily covered banking stocks at SKBA Capital Management, while Lieberman tracked insurance companies at Sanford C. Bernstein.

"We both saw from the inside how hard it is to add value over indexes," Abramson said.

Nobel prize-winner William Sharpe was also a big influence in their transformation to index investing. The professor met Lieberman's father, who was also in the money management business and served as an original member of ELM's team, years ago when both worked at Stanford University.

Sharpe's work on capital asset pricing models "had a huge impact on our thinking about the efficiency of capital markets," Lieberman said.

"We've come to the conclusion that markets aren't perfectly efficient, but it's best to act like they are," Abramson said.

Zero-Sum Game 

Stock markets are still brutally competitive, he adds. That's even truer today with the proliferation of hedge funds and technology. "And the drag of costs for active management makes it a zero-sum game and puts managers at a disadvantage from the outset," Abramson said.

ELM uses stock exchange-traded funds to heighten tax efficiencies in portfolios. It also invests through Dimensional Fund Advisors and Vanguard open-end index funds. On the fixed-income side, the advisory prefers to build individual bond ladders for clients.

An average portfolio run by ELM has a weighted average expense ratio of around 0.17% right now.

Typically, Abramson will recommend seven to 10 core stock ETFs or diversified funds. "Taking a value approach with a dedicated bias to small-caps makes sense to us," he said. "Investors can reasonably expect a greater return over time since value stocks and small-caps have greater volatility and risk."

The couple use Vanguard Total Stock Market ETF (NYSEArca: VTI) and Vanguard FTSE All-World ex-U.S. ETF (NYSEArca: VEU) for broad large-cap building blocks. And then they'll use SPDR S&P International Small Cap (AMEX: GWX) for additional diversification.

On the domestic side, Abramson likes to use some of the Vanguard Small-Cap ETF (NYSEArca: VB) along with the DFA U.S. Targeted Value (DFFVX) mutual fund for small-cap value exposure.

"We also see value in diversifying through REITs," he added, suggesting the Vanguard REIT ETF (NYSEArca: VNQ).

Abramson also has a long-standing interest in socially responsible investing. In fact, he's had research published in the field by the Journal of Investing and others.

"Even with the low-cost SRI funds we favor, the expense ratios are higher. So there's a cost involved in building social investing screens into funds," said Abramson. "It's important for people to realize that fact and to go into SRI funds with their eyes wide open."

A Layered Approach 

First and foremost, he adds, SRI investing should be considered an overlay of traditional indexing.

"You can't forget the underlying fundamentals of passive investing," Abramson said. "You can create diversified, socially responsible investment portfolios that are still focused on the best aspects of low-cost, diversified indexing. But there are still some gaps in terms of what asset classes are available with SRI funds in the marketplace."

Two core U.S. stock mutual funds he uses for investors interested in SRI investing are the Vanguard FTSE Social Index Fund (VFTSX) and the TIAA-CREF Social Choice Equities Fund (TICRX).  

ELM doesn't target commodities exposure or other alternatives exposure. "Our clients get exposure through energy companies and commodities producers already held in their broad market index funds," Abramson said. "We're not sold on the value of overweighting commodities or energy."

Part of his reasoning for avoiding targeting direct exposure to commodities is due to the work of David Swensen, who runs Yale's endowment portfolio.

"I love his second book, which is geared towards individual investors and makes no mention of the need for commodities exposure," Abramson said. "And even John Bogle has pointed out that commodities have no intrinsic value—they're not producing assets."

ELM also believes in rebalancing once asset classes move outside of certain performance bands.

"That's something we're continuing to monitor," Abramson said. "Right now, that's something we're looking at on the stock side—rebalancing asset classes to make sure people aren't falling too far below their target asset allocation levels."

-- This report was submitted by Murray Coleman.

Murray Coleman's article paints an ugly picture of how fixed-income ETFs are functioning right now.

Murray focuses on premiums and discounts in the fixed-income space, which is a huge story: fixed-income ETFs are trading at wild variance with their underlying indexes.

There are a variety of reasons why. The fixed-income market is so frozen right now that some bond price indexes are carrying stale data. At the same time, some ETFs are using "fair value" pricing to value their illiquid holdings, which introduces a layer of discretion into how each fund's assets are priced.

To be honest: It's hard to know exactly where these things should be trading. And that, to me, is a big problem.  

The whole idea of investing in ETFs is that they give you clean access to various asset classes. You set your asset allocation---X% in stocks, Y% in bonds, Z% in commodities---and ETFs give you fair exposure to those markets.

Right now, they are not doing that.

Consider the three junk bond ETFs: the iShares iBoxx $ High Yield Corporate Bond (NYSEArca: HYG), SPDR Lehman High Yield Bond ETF (AMEX: JNK) and PowerShares High Yield Corporate Bond Portfolio (AMEX: PHB).  All three funds track high yield corporate bonds, holding portfolios of 50, 112 and 52 high yield bonds, respectively. You'd think their returns would be similar.

But let's say you bought shares in each fund at the close of trading on October 3^rd. Since then, through 3:30pm ET on October 13, HYG is down about 8.5%, while JNK and PBM are down 17%. That's an 8.5% swing in 10 days.

It's worse if you look intraday. At one point last Friday, HYG was down about 15%, JNK was down about 20% and PHB was down nearly 30%. 

Of the three funds, HYG appears to be trading the best. On an intraday basis it has been trading fairly smoothly, while the other two ETFs have vacillated wildly.

But a 15% difference? Intraday?

Buyer beware.

In fact, Murray Coleman was way ahead of the story.

Murray's story on the Opta ETNs posted to our Web site at 2:27 p.m. on Friday, September 12, titled "Lehman Meltdown Raises ETN Questions." At the time, Lehman Brothers was still a going concern, and the Lehman Brothers Opta ETNs were trading as normal on the New York Stock Exchange.

Murray wrote: "With Lehman Brothers fighting to stave off bankruptcy, shareholders of the once-mighty investment bank aren't the only ones facing possible big losses. Those owning exchange-traded notes issued by the firm could face a tough time getting out of their investments at fair market value if things take a dramatic turn for the worse."

The article goes on to call the risk "small"—something I as an editor inserted, after discussing Lehman's prospects with you, Jim. But the point is, Murray put out an excellent story that warned investors about the risks of holding Lehman ETNs while those ETNs were still trading. A risk-conscious investor could have read that story and said, "The upside of holding these ETNs is limited and the downside is enormous; I should sell."

I hope they did. Anyone who held those ETNs that weekend was taking a tremendous risk for which there was no compensating reward.

That's what the best investment journalism does; alerts investors to risks while they can still do something about it.

The idea that Barclays was going to step in and pay off the ETNs as part of its agreement to buy Lehman's investment banking and trading operations was a fantasy. The Opta ETNs were general obligations of Lehman Brother's Holdings, and Barclays was very careful to exclude those debts from its buyout. It specifically did not want to take on the structured product debt from Lehman, and it could hardly pay off some but not all of the structured products. Just imagine the outcry!

Once Lehman filed for bankruptcy, those ETNs were over.

The Lehman Brothers story drives home an important point: Credit risk is very real in the ETN business, and it is also digital. Either the bank stays solvent and you receive 100% of the index return, or the bank goes bankrupt and you're toast. There is no Mr. In Between.

Let's hope investors understand that.