In case you missed it, ProShares announced today that it will pay zero capital gains on its complete family of ETFs in 2009. That’s shocking, given the huge cap-gains payouts by inverse ETFs in 2008. I would have thought, given the huge run in the market this year, that leveraged funds would have accumulated large distributions.

In fact, I had a half-written blog warning investors to sell out of leveraged ETFs ahead of the 2009 distribution announcements. I was worried that investors would get stuck with large distributions yet again, and didn’t want to see that happen. It was lucky timing that the ProShares announcement jumped ahead of me publishing that blog.

The question now is, will other leveraged and inverse ETF providers like Rydex and Direxion Shares follow suit?

On one level, I think the answer is yes. Given the zero gains at ProShares, it’s unlikely we’ll see the kinds of distributions we saw in 2008, where funds paid upward of 30 percent (and in one case more than 80 percent) of their net asset values in capital gains.

But I wouldn’t look for zero capital gains across the whole universe. The largest gains in 2008 were concentrated in smaller funds, and if I were a tax-sensitive investor, I’d be worried about funds with small assets under management going into the 2009 distribution season.

There are lots of things that ETF providers can do to manage tax distributions, including using the creation/redemption facility to effectively distribute gains to institutional investors during the course of the year. But smaller funds that have less creation/redemption activity are limited in their ability to do this.

My guess is that we’ll still see some capital gains distributions in the leveraged space in 2009, but they will be nothing like what we saw in 2008, and will be focused on the smaller, less-loved funds.

Leveraged and inverse ETFs are most appropriate for traders who may not care about capital gains distributions. But investors in leveraged ETFs outside of the ProShares family may still want to be on their toes as we move into distribution season.

Law Firms Threatening Action Against Leveraged ETF Providers

At least two law firms say they're talking to clients who use leveraged exchange-traded funds about potential lawsuits against the funds' providers.

The list is large and includes ETFs sponsored by ProShares, PowerShares, Direxion and ETF Securities, which recently entered the U.S. (see story here.)

How do we know this? The law firms, of course, put out a press release. You can read it here.

Two Deutsche Bank Funds Hit By CTFC Ruling

A pair of PowerShares-DB commodity ETFs will be curtailed in how much they can buy in soybeans, wheat and corn due to a decision by the Commodity Futures Trading Commission.

You can read this Bloomberg News report for more details. Also, check Matt Hougan's blog here.

SSgA's Hoguet: Sovereign Wealth Funds To Buy SDRs

Special drawing rights, or SDRs, are what the International Monetary Fund uses internally as currency markers to traverse its global reach. China has nominated SDRs as a natural new world currency, replacing—or complementing—the de facto U.S. dollar.

When the suggestion was made, critics voiced their displeasure at the notion. But now, according to this interesting Reuters report, several big sovereign wealth funds are considering buying SDRs.

The report is based on information supplied by George Hoguet, a State Street Global Advisors emerging markets expert. (His work has been profiled at IndexUniverse.com several times in the past few years, including a Q&A earlier this year.)

You can read the Reuters story here.

Fidelity President Looking For Successor

Rodger Lawson, who took over as president of Fidelity Investments in 2007, tells Bloomberg News he's looking for a replacement. The position has been a bit of a revolving door at the mutual funds giant in recent years.

The story addresses that issue and also includes Lawson's rebuttal of Morningstar data showing the company is lagging its peers in performance, particularly compared with arch rival Vanguard. (For more about the battle between Vanguard and its competitors, see related story here.)

You can read the Bloomberg interview with Lawson here.

In related news, Fidelity says its assets rose to $2.8 trillion. See a Wall Street Journal story on the firm's finances here.

Hedge Fund Bets Big On Natural Gas Prices

It might be interesting to note that with all of the furor going on over UNG and commodities markets, a hedge fund has apparently made a rather large bet that natural gas prices will triple by winter.

The Financial Times story also gets into the most recent forecasts for the market from analysts and their reaction to the unusual play.

You can read the story here.

Earlier this month, NYSE Euronext completed its acquisition of the American Stock Exchange. With the addition of AMEX's 416 ETF listings and 13 ETNs, the exchange-traded product listings at NYSE Euronext now number 680, excluding overseas ETFs, and a total of $595 billion in exchange-traded product assets.

IU.com's Eric Rosenbaum recently spoke with NYSE Euronext Senior Vice President Lisa Dallmer about the specific benefits of the completed acquisition for the ETF industry, and the current outlook for ETFs given the tough markets. 

IndexUniverse (IU): With the Amex deal completed, what are the major benefits to the NYSE as a competitor for ETF listings and ETF servicing business, beyond the bragging rights that are always a part of the battle among exchanges for market share?

Lisa Dallmer (Dallmer): At the broadest level, it's the bundling of the Amex historical strength in ETF listings, and our stronger technology platform. That allows us to create a best-of-breed approach for exchange-traded products. We've made our own strides in the listings business over the past few years, and already listed the biggest names in the ETF business-iShares, Vanguard Group, PowerShares, to name a few. ETFs will now have the largest listings platform aligned with a much better trading platform. This is not only important for the ETFs, either, but for the traders that make markets for ETFs. Firms in order routing and specialist firms, will benefit by the removal of a now redundant trading platform. That AMEX platform has routing costs associated with it, and going forward, those costs will be eliminated. To be frank, the AMEX market share in transactions and order flow has been low, but firms still needed to maintain connections to that platform, and that had a cost.

IU: When will the elimination of the AMEX platform and the movement of all ETFs to the NYSE Arca platform be completed?

Dallmer: As of Dec. 1, we will no longer support the AMEX trading technology for equities and ETFs. On the last day of November, ETFs will all move to NYSE Arca, and on Dec. 1, equities will follow to NYSE Alternext supported by NYSE technology. ETF issuer support has been strong for the migration to NYSE Arca, even before the deal was completed. The Vanguard Group, for example, went ahead with a third quarter migration of ETF listings to NYSE Arca, 10 days prior to the closing of the deal (see story here).

IU: Can you provide a specific example of how the NYSE's trading platform advantage directly benefits ETFs?

Dallmer: There are some very good statistics, at least initially, in support of the idea that our technology has an immediate, and positive, influence on ETF trading patterns, versus what ETFs experienced when listed on the AMEX. As an ETF issuer, you want to see trading activity take place on the primary exchange where you list. That supports the regulated market aspect of listing with an exchange, among other exchange service functions. Amex may have had the majority of ETF listings, but that did not translate into a dominating position in ETF trading. Amex had struggled with technology and that led to a pattern of competitors chipping away at the trading volume. To see if that might change for ETF issuers with the move to NYSE Arca, we looked at some data since Vanguard moved its ETFs. The Amex numbers for Vanguard ETFs, in particular, were much lower at the open and close.

In the month prior to the transfer, NASDAQ had 57.9% of the open to Amex's 42.1%. Since Sept. 19, and through Oct. 17, Arca has executed 97.4% of the shares in the opening cross in those issues. NASDAQ's total volume per day is down from 120,000 to 11,000 in those stocks. Amex was executing 88,000 per day at the open, while Arca is currently at 419,000 at the open (although the gross shares executed may be due to recent high volumes, the share is still astounding). At the close, Amex had still been at about 91% share in these issues. Arca is at 99.8%. However, close volume in these issues totals (across all the ETFs) about 29,000 shares per day (Amex had been 9,700). The lead market maker program that we created in our market structure, and our technology pushed those trading numbers up.

IU: The AMEX had some interesting initiatives in the area of ETF servicing. One, in particular, the so-called "black box" or "scrambler" technology for non-transparent portfolio disclosure of actively managed ETFs, has been an important part of the ongoing efforts to bring actively managed ETFs to market. Where does this initiative stand today, and what are any other initiatives that came out of the Amex's history in the ETF servicing business, that the NYSE will want to focus on as a combined ETF servicer?

Dallmer: With respect to the "black box project" as you refer to it, we are still working on the technology and with ETF issuers and regulators. There is a proposal in front of the Securities and Exchange Commission now detailing how the service would work to permit listings for a non-transparent actively managed ETF. NYSE Arca has developed strong expertise in the regulatory rule development process behind bringing new products to market. We brought the first commodity trust, SPDR Gold (GLD), and the first ETN to market, and we were early backers of index-linked certificates. We've also worked with ETF issuers and the SEC on permitting ETFs of ETFs. I'd also note that one type of product support we can now incrementally offer to AMEX relationships is listings on a global basis. NYSE Euronext is a global marketplace and for ETF clients like iShares, Invesco Powershares, and State Street Global Advisors, there are cross-listing agendas we can fulfill. We already cross-list one ETF into Europe, The Diamonds, and are working on fine- tuning that process so that under appropriate regulatory guidance, there is an easier path for further cross-listing by ETF issuers [Powershares recently listed two versions of ETFs offered in the U.S. in Europe, one on Deutsche Borse's Xetra and one on the London Stock Exchange].

IU: How will new ETF products get to market with seed capital so scarce, and with markets so beaten up?

Dallmer: During a period in which markets are down 4% or more a day, and asset pricing levels down by 20% to 40%, your vetting process for new products changes, with "fourth or fifth fund into a category" typically thrown out. The ETF market has been historically long-only, but already we are seeing the movement to products non-correlated to equities-such as fixed-income, commodities, and currency. Even before the market sell-off there were strong inflows of cash to those ETF categories. Ultimately, I don't believe ETF success will be about the availability of seed capital or market conditions. It's about gathering assets. Developing a distribution channel for a fund before it launches has been a strong theme for successful ETF launches in 2008.

IU: How can ETFs with a low level of assets ride out the current market downturn?

Dallmer: To the extent that a fund provider has certain fixed costs, it becomes increasingly difficult to support small asset bases in a down market. There have been some liquidations already, in cases where ETF groups were not finding it cost effective to keep portfolios trading. But the market structure that provides efficiency of trading is the same regardless of asset size, the market rules the same for a $5 billion ETF and a $10 million one. Also, an important difference between ETFs and traditional open-end funds is the lower fixed cost structure for ETFs. There are no transfer agency costs and no shareholder recordkeeping costs. From that perspective, an ETF provider with a low level of assets has less hurdles than a small open-end mutual fund.

No doubt, a very large ETF provider with existing economies of scale to support its fixed costs will more easily be able to add new portfolios, especially in cases where the strategies are more niche and where $100 to $200 million might be a very successful launch. It's no different than any other business: one revenue stream can't support multiple pieces. And yet, keep in mind that we've had ETF providers like WisdomTree Investments and ProShares grow extensively over a relatively short period of time.

IU: Do you expect that the current market environment will slow the growth of ETFs?

Dallmer: The mass exodus has been from open-end mutual funds. ETFs have not seen those same outflows, and their design has enabled investors to buy into, or exit exposures, intra-day. That has been a valuable feature in this market. When we come to the end of the year, I think comparison of index mutual funds and index ETFs that track the same index will show wide divergence, based on tax-efficiency, in the performance of ETFs versus open-end funds. Heavy turnover creates a situation in which investors using ETFs can really outperform similar open-end fund investors. And remember, all those investors leaving open-end funds in droves, they will eventually go back into the markets to reinvest. Maybe it was 7 to ten years ago that they first invested, and there was not even an ETF available to them. Now those investors are taking their capital gains hits and when they head back into the markets, it may be into ETFs and not back into open-end funds. So that's a big opportunity for ETF companies.

This from Today’s Financial News:

Thanks to fears of a strong global recession and larger-than-expected downturns in pivotal countries like China and India, crude prices are on the decline. Right now, a barrel of oil is selling for nearly half of what it did during its record-smashing peak just a few months ago.

But we have not seen anything yet. Crude prices will continue to fall. And if you invest accordingly, you can put some hefty profits in your pocket.

Earlier today, OPEC announced it has significantly reduced its oil-demand forecast. The group says it now believes…

This from Today’s Financial News:

Thanks to fears of a strong global recession and larger-than-expected downturns in pivotal countries like China and India, crude prices are on the decline. Right now, a barrel of oil is selling for nearly half of what it did during its record-smashing peak just a few months ago.

But we have not seen anything yet. Crude prices will continue to fall. And if you invest accordingly, you can put some hefty profits in your pocket.

Earlier today, OPEC announced it has significantly reduced its oil-demand forecast. The group says it now believes…

This from Today’s Financial News:

Thanks to fears of a strong global recession and larger-than-expected downturns in pivotal countries like China and India, crude prices are on the decline. Right now, a barrel of oil is selling for nearly half of what it did during its record-smashing peak just a few months ago.

But we have not seen anything yet. Crude prices will continue to fall. And if you invest accordingly, you can put some hefty profits in your pocket.

Earlier today, OPEC announced it has significantly reduced its oil-demand forecast. The group says it now believes…

The index was dragged down by General Motors (NYSE:GM), which fell to a 58-year low as sales in Europe dried up.

This from Reuters:

The energy sector was the top drag on the Dow as the price of oil fell.

"We've got a disappointment that everything that's been done to date and everything that's being contemplated has not had any significant impact ... to reduce the credit freeze-up and it now looks like it's spread worldwide," said Bucky Hellwig, senior vice president at Morgan Asset Management, in Birmingham, Alabama.

"You've got investors concerned that the global slowdown that had been feared may be materializing, courtesy of the frozen credit markets."

PS.  Earlier today, Eric Roseman recommended investors hold reverse ETFs like Short Dow30 ProShares (AMEX:DOG) or Short S&P500 ProShares (AMEX:SH) in their portfolio. These funds are sitting on gains of 3.5% and 4.2% just in today's trading session

Trading has reopened on the ProShares Short Financials (AMEX: SEF) and ProShares UltraShort Financials (AMEX: SKF) ETFs, after being halted this morning as part of the fallout from the SEC's ban on short-selling in Financial stocks.

See our earlier story on the topic here.

The two ETFs are not functioning normally, however: ProShares has banned "creations" until further notice, meaning that no new shares can be created to fill demand. Shares can, however, be redeemed as usual by Authorized Participants.  

What does this mean for the average investor?

It depends. Importantly, investors can still buy and sell the shares of both funds; in fact, more than 10 million shares of SKF have traded today, with high liquidity and tight spreads.

However, ProShares has warned in a statement that "these ProShares ... may trade at prices that are not in line with their intraday indicative values."

In other words, the share price may not match the expected returns. SKF seeks to deliver -200% of the daily movement of the Dow Jones Financial Index, while SEF aims to deliver -100% of the index's daily returns.

At midday, SKF was trading more or less in line with expectations. The fast-moving nature of the markets made it difficult to say exactly how close it was to its underlying indicative value at any moment, but generally, it was in the vicinity. Three different checks of real-time prices over a 1-minute period showed SKF trading in line with expectations once and at a premium of about 1% over expectations twice.

The possibility of a premium is what investors should keep an eye on. The last time an exchange-traded product suspended creations was in 2007, when Barclays halted creations on the iPath India exchange-traded note (NYSEArca: INP). That occurred after India clamped down on foreign investment in the country. At the time, INP soared to a significant premium over its net asset value, and stayed there for many months as demand for the shares exceeded supply. INP was then one of the few ways U.S. investors could gain access to the rising Indian equity market.

A similar situation could develop with SKF if sentiment on the Financial sector turns negative. SKF is likely the "go-to" product for traders looking for short exposure to that market, as they can no longer short individual Financial stocks and the competing ETF from Rydex (NYSEArca: RFN) is less well known and currently has little volume. If investors were to turn to SKF on a large-scale level, the risk of a premium would rise.

When asked how long the ban on creations would last, Michael Sapir, CEO of ProShares, said, "I think everyone acknowledges that the SEC order [banning short-selling on Financials] is a temporary situation. I think it's commonly held among the regulators that being able to get short exposure is a good thing for the economic system. So we believe this [suspension] is temporary."

When asked if that meant the suspension would stay in place until the SEC ban expires, Sapir replied:

"We're looking into our options. In light of the SEC's really unprecedented action, we determined it was unlikely to get short exposure to cover new shares today, so we decided not to issue new shares. But investors can buy and sell shares on the exchanges. SKF—the very liquid double inverse ETF—has traded 10 million shares with tight spreads. People who want to sell their positions or buy new positions can do so."

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