EFT, Exchange Traded Funds by munificent .....

Exchange Traded (Index) Funds~ less costs than a regular Mutual Fund (not saying much!) I've just done an extensive study on iShares EFT's for a Yoga buddy of mine, and I must say I like them. At first I thought them to be like Closed End Funds, the idea of trading on an exchange is identical- the difference is the engine inside the wrapper ~indexing. Let's face it most indexes have beat their Mutual Fund counterparts- Consider the trading expenses, paying the money manager ungodly sums, and all the admin work that accompanies this structure-so it makes sense that the indexes won...In a robust upward trending market~ maybe not...We'll have to wait and see until we're there again! At any rate, if you can't own positions in individual stocks at 50-100 shares per position minimum- then EFT's make a great portfolio-be ware not to duplicate industries and internal positions within the indexes when picking more than one EFT.

Date:   7/11/2005 9:36:43 AM ( 16 y ago)

Exchange-Traded Funds, in a Rainbow of Choices

Published: July 10, 2005
A 128-CRAYON box of Crayolas does not guarantee a better drawing than the standard eight-crayon version, but any child will tell you that more is better. And so it goes in the fast-growing world of exchange-traded funds, as marketers busily dream up new shades of index-tracking portfolios for investors who have recently adopted these funds as the new "it" investment.

Noah Berger for The New York Times
Lee T. Kranefuss, chief executive of the E.T.F. business at Barclays Global Investors iShares, says smaller investors now account for a majority of iShares' net sales.

Carol T. Powers for The New York Times
John L. Jacobs, chief marketing officer at Nasdaq, says the retail investor who wants to invest $100 a month in an E.T.F. has been neglected.
"If you asked me three years ago I would have told you I thought the industry was already filling out," says Jim Wiandt, publisher of Exchange Traded Funds Report and editor of Journal of Indexes. "But the innovations and new products we are seeing now make this feel like just the beginning."

E.T.F.'s are like traditional index mutual funds but offer the added feature of pricing throughout the day; by contrast, mutual funds are priced just once a day, at the close of the market. Adding to the allure of E.T.F.'s are annual operating fees that are typically lower than those of mutual funds, as well as greater tax efficiency.

At the end of May, E.T.F. assets totaled $238.2 billion, almost three times the $83 billion at the end of 2001. And there were 163 of these funds in May, up from 102 in 2001. While the current assets would not be much more than a rounding error for the $8 trillion mutual fund industry, exchange-traded funds are creating a buzz as their base expands beyond institutional clients.

Lee T. Kranefuss, chief executive of the E.T.F. business at Barclays Global Investors iShares, which commands more than 50 percent of total E.T.F. assets, says retail investors accounted for about 20 percent of iShares' net sales a few years ago but are now responsible for 60 percent of net inflows. In a nod to the individual investor, iShares enacted stock splits last month on 12 E.T.F.'s whose share prices had pushed beyond $100.

The notion of catering to the small investor is spreading throughout the market. Morningstar, the mutual fund research firm that also tracks E.T.F.'s for individual investors and financial advisers, recently added an analysis tool aimed at assessing the discount or premium - as estimated by Morningstar - at which an E.T.F. trades, relative to the fair value of its underlying securities.

John L. Jacobs, chief marketing officer at Nasdaq, said that investors would soon be able to buy shares of the popular Nasdaq 100 Trust E.T.F. (symbol: QQQQ) directly from the exchange at low or no cost. Right now the only way to buy E.T.F. shares is to pay a brokerage commission. Some discount brokerage firms charge a fee of $10 or $20 a trade, but even that may seem too high for investors who make frequent investments.

"The retail investor who wants to invest $100 a month in an E.T.F. is underserved right now," Mr. Jacobs said.

Sharebuilder, a brokerage firm in Bellevue, Wash., specializing in periodic investing, is also taking E.T.F.'s to the retail crowd by charging a maximum commission of $4 on trades. The chief executive, Jeffrey T. Seely, reported that four years ago, just one such fund, the Nasdaq 100 Trust, would pop up among the 20 most popular investments of Sharebuilder customers. Today, he said, eight or nine exchange-traded funds are in the top 20. "It's definitely a growing part of our business," he said.

THE pickup in the retail business began amid the market declines of 2001 and 2002; chastened investors focused on the often-ignored maxim that very few managers could consistently outperform benchmark indexes. That spurred interest in both regular index mutual funds and E.T.F.'s.

Throw in a large E.T.F. promotional push by Barclays, and a mutual fund trading scandal in 2003 that involved market manipulations not possible with exchange-traded funds, and E.T.F.'s were ready for their close-up.

According to Journal of Indexes, indexing accounted for less than 10 percent of equity investments in 1999; mutual funds pulled in 9 percentage points of that total and E.T.F.'s less than 1 percentage point. Today, nearly 17 percent of equity money goes into indexing, and E.T.F.'s account for 5.1 percentage points of that inflow.

Exchange-Traded Funds, in a Rainbow of Choices

The popularity of the funds has continued to rise. The iShares MSCI EAFE portfolio, which was started in 2001 and tracks the Morgan Stanley Capital International index of European, Australasian and Far Eastern stocks, had net sales of $6.62 billion last year and an additional $2.76 billion through the first five months of 2005. Its $16.5 billion in total assets was far higher than the $9.6 billion invested in the nine-year-old Vanguard Total International Stock Index, a traditional mutual fund. The iShares MSCI Emerging Markets E.T.F., which began in 2004, already has $5.7 billion in assets, and iShares FTSE/Xinhua China, opened in late 2004, currently has $926 million.

The E.T.F.'s Share
Another big hit with retail investors has been the iShares Dow Jones Select Dividend, which was started in late 2003 to capitalize on lower federal tax rates on stock dividends. This fund collected more than $4 billion last year, and the $1.7 billion invested in 2005 makes it the second-most-popular E.T.F., behind the MSCI portfolio. In 2004, iShares was the third-fastest-growing fund group of all types, behind American Funds and Vanguard.

Sector E.T.F.'s are also registering with investors. State Street Global, the No. 2 E.T.F. shop behind Barclays, reported that assets in its nine Sector SPDR E.T.F.'s - each tracks a portion of the S.& P. 500 - jumped 52 percent in 2004 and were up an additional 26 percent this year through June, to nearly $12 billion.

Mr. Kranefuss and other industry experts say they expect commodities to be the next frontier. Last November, State Street Global started the first domestic commodity E.T.F.; in just two months, the fund, streetTracks Gold Shares, collected more than $2 billion. Barclays started its own gold E.T.F. in January - the portfolio has $171 million in assets as of July 1 and recently announced plans to apply to the Securities and Exchange Commission to offer one for silver.

In May, Ameristock filed papers seeking S.E.C. approval for an E.T.F. that would track the price of crude oil. And Rydex recently filed an application for a currency-based E.T.F. that would track the euro.

Mr. Wiandt of Exchange Traded Funds Report says strong demand is possible for eight E.T.F.'s proposed by ProFunds. Four would be leveraged portfolios aiming to double the returns of their target indexes, and four would be so-called inverse portfolios aiming to double the opposite return of their benchmark indexes. ProFunds filed its application with the S.E.C. in 2002 and is still awaiting approval.

And there is constant noise that actively managed E.T.F.'s could be the next big trend. After all, it's not lost on marketers that more than 80 percent of investor money still goes to actively managed mutual funds. But there are tough logistical hurdles - mainly, how to telegraph to investors what a portfolio currently holds without tipping the managers' hand. So far, no one has filed an application with the S.E.C. for an actively managed fund.

Paul J. Mazzilli, director of E.T.F. research at Morgan Stanley, says that this is a good thing. "Once you introduce active management to an E.T.F., it would lose two of its main advantages: low fees and high tax efficiency."

A product known as enhanced E.T.F.'s could become a popular middle ground between passive indexing and active management. Enhanced E.T.F. portfolios are tied to a benchmark index, but managers use quantitative analysis to cherry-pick investments within the index. PowerShares, which had already offered 11 enhanced E.T.F.'s with $1 billion in assets as of June 23, introduced eight new ones late last month.

Along with the parade of new E.T.F.'s, investors are being treated to intense fee competition. Like mutual funds, all E.T.F.'s charge an expense ratio: an annual fee deducted from fund performance to cover operational and management costs.

A big selling point for E.T.F.'s is that their expense ratios, averaging 0.38 percent, are generally much lower than the average of 1.4 percent for an actively managed equity fund, and are often even lower than the fee charged for index mutual funds.

When Fidelity recently made permanent its decision to charge just 0.10 percent on certain index mutual funds, Vanguard, the leader in mutual fund indexing, responded in part by aggressively cutting the expense ratio on many of its E.T.F.'s, known as Vipers.

The Vanguard Extended Market Viper recently lowered its expense ratio to 0.07 percent from 0.20 percent. That means it is now the cheapest E.T.F. on the market, charging less than the previous title holder, iShares S.& P. 500, which has a ratio of 0.09 percent. In the hot international market, Vanguard is aiming to turn the heat higher, offering both a Pacific and a European E.T.F. with an expense ratios of 0.18 percent; the iShares MSCI EAFE currently charges 0.35 percent. "I don't expect iShares to respond until it has to," Mr. Mazzilli of Morgan Stanley said.

Retail investors will have a big say in what happens next.


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