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

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

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

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

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

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

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

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

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

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

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

WisdomTree Investments is changing the investment strategy of two of its dividend-focused exchange-traded funds so that they exclude exposure to the Financials sector.

Beginning in late April, the WisdomTree Dividend Top 100 (NYSE Arca: DTN) will be renamed the WisdomTree Dividend ex-Financials Fund; its international counterpart, the WisdomTree International Dividend Top 100 (NYSE Arca: DOO), will be renamed the WisdomTree International Dividend Ex-Financials Fund.

The funds will become the first dividend-focused ETFs to exclude Financials.

"There are quite a few dividend-focused ETFs on the market today, many of which have significant exposure to Financials," said Luciano Siracusano, director of sales for WisdomTree. "We wanted to provide clients with a choice, to give them the option to get yield without getting exposure to Financials."

The Financials sector tends to be one of the higher-yielding sectors in the market, and dividend-focused ETFs tend to be overweight Financials. The most popular dividend ETF, the iShares Dow Jones Select Dividend Fund (NYSE Arca: DVY), is currently 24.55% invested Financials; that compares to the S&P 500, which is currently just 9.98% exposed.

As of February 25, both DTN and DOO had large positions in the Financials too: 23.18% for DTN and 39.10% for DOO. The funds will trade out of those positions by late April, replacing them with other high-yielding stocks. WisdomTree says that there will be no tax consequences, which is not surprising given that most Financial stocks are trading at multiyear lows.

"We won't know for sure until we calculate the new index, but my instinct is that the change will not have much of an impact on the yield of the fund," said Siracusano. "We have 34 dividend-weighted ETFs on the market. We thought we would take two of them—one domestic and one international—and give people the option to get exposure without the financials exposure."

The filing announcing the move is available here.

-- This report was submitted by IndexUniverse.com's Matthew Hougan. 

Since first jumping into the exchange-traded funds market two-plus years ago with 20 dividend-weighted exchange-traded funds, WisdomTree Investments has firmly been cast as a value-styled management shop.

That focus on weighting index-based ETF portfolios on business fundamentals -- rather than traditional  market-cap size figures -- hasn't changed. But the New York-based firm launched Thursday an ETF focused squarely on large-cap growth stocks.  

But two items stand to separate the WisdomTree LargeCap Growth ETF (NYSEArca: ROI) from the pack.

For one, the new fund focuses on corporate earnings, otherwise known as net income or profit, to weight stocks in its portfolio. That's different from rivals such as the $9.2 billion iShares Russell 1000 Growth Index (NYSEArca: IWF) and the $4.6 billion iShares S&P 500 Growth Index (NYSEArca: IVW). Both use straight market capitalization sizes to determine portfolio weights.

"The only pure competitors for ROI on the large growth side are traditional market-cap-sized indexes," said Luciano Siracusano, WisdomTree's chief investment strategist.

The lowest-priced large-cap growth ETF on the market is the Vanguard Growth ETF (NYSEArca: VUG). It has an expense ratio of 0.10% and tracks the MSCI U.S. Prime Market Growth Index. WisdomTree's ROI is expected to be 0.38% per year.

That leads to the second big point of departure for the new ETF. As an early advocate of using fundamental data rather than market-cap size metrics to weight portfolios, WisdomTree is a pioneering nontraditional ETF provider. Besides dividend streams, its portfolios are branching into another key measure to value businesses -- net earnings.

Assessing The Field

WisdomTree isn't alone in offering nontraditional index-based ETFs. PowerShares has a series of funds based on the FTSE RAFI indexes created by Research Affiliates and FTSE. Those use a broad set of fundamental valuations to design portfolios. The closest in terms of style to ROI is probably the PowerShares FTSE RAFI US 1000 Portfolio (NYSEArca: PRF). But that's categorized as a large-cap value fund by Morningstar.

Another nontraditional ETF provider using different fundamental valuations is RevenueShares. Its closest rival to ROI would be the RevenueShares Large Cap ETF (NYSE: RWL).  It takes the blue-chip universe and weights those names by annual sales. And again, Morningstar categorizes RWL as a large value fund.

The closest competitor is probably SPA ETF's MarketGrader Large Cap ETF (NYSEArca: SZG), which uses a quantitative strategy to select 100 large-cap stocks. It is classified as a large-cap growth fund by Morningstar, although it is not explicitly screened to capture growth stocks alone.

ROI is the only non-traditional ETF with an explicit growth focus.

ROI's index starts with around 300 stocks based on four growth factors: earnings-per-share growth; sales-per-share growth; book-value-per-share growth and stock-price-per-share growth.

By contrast, the Russell 1000 Growth Index uses a combination of price-to-book values and projected earnings estimates. Other benchmarks throw in a few other factors to create a different valuation mix.

"All of the pure growth indexes use multiple factors to select components," said Siracusano. "But they determine weightings in the same way -- by market capitalization sizes."

Even though the benchmark underlying WisdomTree's new fund uses a different methodology to rank stocks, ROI's list of constituents looks much the same as its market cap weighted rivals. For example, some 17 of the top 20 companies listed in the WisdomTree LargeCap Growth Index are also in the Russell 1000 Growth Index as well as the S&P 500 Growth Index.

"But since we weight our index by [net] earnings, the characteristics are different from the other growth indexes," said Siracusano.

Backtested data from WisdomTree shows its index has a lower price-earnings ratio. Here's how it shaped up heading into November:

In the past 10 years through Sept. 30, WisdomTree says its large growth index outperformed the Russell 1000 Growth index by an average of about four percentage points per year. It lists the following average annualized returns for that period:

• 4.76% for the WisdomTree LargeCap Growth Index
• 3.06% for the S&P 500 Index
• 0.59% for the Russell 1000 Growth Index

"We created it to provide investors with an ability to own growth companies, but in a portfolio that has a lower PE ratio than other cap-weighted growth funds," said Jeremy Schwartz, WisdomTree's research director.

Looking Underneath The Hood

The WisdomTree LargeCap Growth benchmark is rebalanced once a year. After its last reconstitution, on March 31, several significant differences showed up compared with growth indexes that stuck to market-cap weighting methodologies.

One was that Apple (Nasdaq: AAPL) was given a larger weighting than Occidental Petroleum (NYSE: OXY). In a traditionally weighted index, the computer maker could expect to receive more than twice the weighting than the oil producer since its market cap was about $127 billion and Occidental's was around $60 billion at the time.

But in the WisdomTree index, more weight was actually given to Occidental since it had greater net profits -- $5 billion compared to Apple's $4 billion.

Another example is Google (Nasdaq: GOOG). It wasn't as high in the WisdomTree index as in the other major growth indexes. Perhaps most notably, ROI had Berkshire Hathaway among its Top 10, whereas none of the other indexes did.

In terms of sectors, Schwartz says that the WisdomTree index has the highest weighting to Technology, just like the S&P and the Russell index. The Vanguard benchmark, the MSCI US Prime Market Growth Index, has 394 holdings and a similar sector breakdown as the Russell 1000 Growth Index and S&P 500 Growth Index.

"We're cutting out the PE multiples from our weightings system," said Schwartz. "We're looking at the bottom line for corporate profits to weight our index."

In other ways, the indexes are similar, even given their distinct methodologies. In terms of holdings, the WisdomTree index has 300 growth stocks, similar to the S&P 500 Growth, which has 315 holdings. The Russell 1000 Growth stands apart in terms of holdings, with 600 stocks. With the lowest number of holdings among the three, the WisdomTree index is the most large-cap-oriented.

ROI's expense ratio is expected to wind up slightly less than PowerShares' lineup of RAFI-based index funds. It  recently lowered costs on the domestic fundamentally weighted ETFs to 0.39%. (See story here.) Meanwhile, the RevenueShares large-cap ETF charges 0.49% a year.  

The annual rebalancing of the Russell/Nomura Japanese stock indexes just concluded, resulting in more than 30% turnover rates for each series in the benchmarking family.

The Russell/Nomura Total Value Index had 212 deletions and 176 additions, while the Russell/Nomura Total Growth Index had 270 deletions and 136 additions.

There are Japanese stock exchange-traded funds from Barclays Global Investors' iShares family, Northern Trust's NETS and from WisdomTree Investments.

JPP and JSC are relatively small ETFs in terms of assets. JSC had close to $73 million in assets through last month while JPP had only $13.5 million.

Among all single-country international ETFs this year, those focused on Japan have held up relatively well in terms of performance. JPP was down 32.15% heading into Monday, while JSC had dropped 23.99% so far in 2008, according to Morningstar data.

That may not seem like impressive performance on the surface, but consider that the broad-based iShares MSCI EAFE Index (NYSE: EFA) for developed international markets has slid more than 45% this year.

The Russell/Nomura Prime Index, which is JPP's index, measures the performance of Japan's top 1,000 float-adjusted stocks. This year, 26 companies came into the Prime Index for the first time and its total market capitalization decreased from 201 trillion yen to 200 trillion yen (as of Oct. 15).

The turnover ratio of the index was 1.6%, which is relatively low compared to previous years, the companies said in a statement.

The number of stocks in the Russell/Nomura Small Cap Index, JSC's underlying index, dropped by 76 companies to 1,100. The small-cap index represents the top 85% and bottom 15% of the Russell/Nomura Japan Equity Index, on a market capitalization basis.

The decrease in JSC's index reflected the larger decline in the capitalization of small-cap companies relative to the overall market decrease.

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.