Lipper Research Senior Analyst Don Cassidy on "Business for Breakfast" 1060 KRCN Tuesday - Exchange-Traded Funds
Tuesday, September 20, 2005
Q. Don, we haven't talked for some while about Exchange-Traded Funds or"ETFs." What's been happening there?A. ETFs have continued to grow in assets and popularity this year.
Q. How big are they now?
A. Well, there are now more than 190 of them, and still growing. Assetsat the end of August were over $260 billion, which is more than 5% as muchas there is in all EQUITY mutual funds ($4.875 Trillion). And we're seeingsome product variety and innovation. There is now more money in ETFsthan in all sector funds; or in Large-Cap Growth funds; or in allclosed-end funds.
Q. That's pretty impressive when you make those comparisons. What's led tosuch popularity for ETFs??
A.
- Their STRUCTURE (you can trade them all day, unlike mutual funds --which price only on the close).
- Their LOW COST (expense ratios are low since these are unmanaged indexbaskets in almost all cases).
- Their STRONG TRACKING to underlying index values, vs premium/discountuncertainty in closed-end funds.
- Their wide VARIETY of underlying asset classes.
- Their CLEAN RECORD (a help in the post-Spitzer funds trading scandalperiod).
- Their FLEXIBLE USES for investors and traders.
Q. We'd better take those one at a time...
A. Sure. ETFs trade on stock exchanges, mainly the AmEx or NYSE. So theyhave ticker symbols and you can use all the same variety of orders (market,stop, limit, short etc) that you can with individual stocks. A greatwebsite resource is www.ETFconnect.com
Q. So if the market moves a lot during the day, you can buy or sell an ETFright when you want to.
A. Exactly, unlike with conventional mutual funds, where you wait untilafter the close and then trade at an unknown price.
Q. And low cost is important to many investors...
A. Right. Indexing has captured about 12% of all equity mutual-fund assets,and continues to gain a little market share. ETFs are index funds thattrade all day. Since they are unmanaged, they have low expense ratios. TheSPY for the S&P 500 costs only about 9 basis points a year! So long-terminvestors -- not just traders -- can see attraction in ETFs based on lowexpenses.
Q. You mentioned "tracking?"
A. Right. That refers to how close the market prices of the ETFs are,minute by minute, to the true values of the underlying baskets ofsecurities in them. We seldom see drift of more than 1/2 of 1%, and it isusually tighter than that for the major products like SPY, DIA, and QQQQ.Whatever is most actively traded is very close to its true value, becauseinstitutions can do arbitrage if any price/value gaps should arise.
Q. So that makes them more reliable, price wise, than closed-end funds.
A. Right. People seem to be more risk averse than risk seeking, so premiumsand discounts are not really popular. In fact, a number of country ClosedEnd Funds have actually been open-ended because the competing ETFs becamemore popular to trade.
Q. And you said there are about 190 ETFs with lots of variety?
A. Definitely. There are only about six bond ETFs, although that includesthe popular Treasury Inflation Protected bonds item. But equity ETFs are byfar the biggest attractions. You can find country or region ETFs, about 70domestic sector choices (some duplicates in there), styles like small-capvalue or large-cap growth, major indexes like the S&P 500 or NASDAQ or theDow 30 -- and even a couple of commodity plays.
Q. Those should be quite interesting this year, with all the energy andinflation talk.
A. Right. There are two gold ETFs, one of which actually trades at theprice of 1/10 of an ounce. We've seen filings for an oil ETF and one forsilver too.
Q. You mentioned the clean record of ETFs?
A. Right. What made possible the kind of activity that became the tradingscandal in mutual funds is that they have fixed once-daily pricing, andsometimes the NAVs can be stale depending on how accurately and timely theunderlying securities are priced. In ETFs, no one can cheat, since theprices are determined by an open bid/asked situation on the exchange. AndETFs can't impose exit fees like the 2% charges some funds are adding asthey try to deter trading. ETFs are traded stocks!
Q. And you mentioned flexibility as an "asset" for ETFs.
A. Right. You can buy them, and you could sell them short too, which isimpossible with mutual funds and often difficult with closed-ends. You canalso use ETFs to over-weight or under-weight parts of the market when youwish, or to hedge.
Q. Example of that?
A. Sure. Suppose you have a health-care fund but you think that the bigdrug stocks will lag due to lawsuits. You could short one of thepharmaceuticals ETFs to neutralize that position. Of if you wish yourfavorite fund had MORE biotech, you could add that for yourself by buyingone of the biotech ETFs. You could use ETFs to hedge something you have abig gain in, so you can postpone the gain tax-wise into a new year withoutviolating IRS wash-sale or tax-timing rules.
Q. Which are the largest ETFs now?
A. A half dozen of the largest:
- SPY "spiders" (S&P 500) $47.2 Billion
- QQQQ (Nasdaq) $19.3 B
- MSCI EAFE $18.8 B
- iShares S&P 500 $13.8 B
- MidCap Trust $ 8.4 B
- iShares Japan $ 7.2 B ( now actually a littlebigger than the "DIA" Diamonds for the Dow 30 ($7.0 Bn) ! )
Q. Thanks Don!
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Don Cassidy is a Senior Research Analyst at Lipper specializing in fund flows, exchange-traded funds, (ETFs), closed-end funds, equity fund performance, and author of Trading on Volume (McGraw-HIll).
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