Investment

» SteveT - Too Many ETFs?

By LAWRENCE C. STRAUSS

CALL IT THE ETF GOLD RUSH. Nowadays, various firms are launching exchange-traded funds, hoping to capture a piece of a fast-growing industry. There are currently 273 exchange-traded funds in the U.S., with assets already up some $335 billion year to date, compared with 204 funds with assets of $304 billion at the end of 2005, according to Deborah Fuhr, a strategist who covers ETFs for Morgan Stanley.

To some, however, the overlooked questions are whether too many funds are being rolled out; whether too many are too narrowly focused; and whether they are good for long-term investors.

"It is possible to take a good thing too far," says Gus Sauter, the chief investment officer at the Vanguard Group, which has 24 exchange-traded funds, known as Vipers, 11 of them sector-focused. "There are so many niche ETFs being delivered now, you have to ask yourself: How many people really need them?"

Exchange-traded funds are like mutual funds, with one big added advantage: They can be bought or sold throughout the trading day, with share values determined by the prices of their underlying holdings. Of course, some of these products are geared to institutional investors or to sophisticated individuals, and aren't suitable for the typical small investor.

One firm hoping to capture a slice of the market is ProShares, which along with the American Stock Exchange recently launched eight funds, four of which enable investors to get short exposure to an index, including the Standard & Poor's 500, the Nasdaq 100 and the Dow Jones Industrial Average. (Investors can short ETFs just like individual stocks; these funds have a short position embedded in the portfolios.)

The funds should be used "as a tool within an overall portfolio," says Michael Sapir, the chief executive of ProShare's ProShare Advisors. "We're all about delivering to investors exposure to slices of the financial marketplace."

Other players in the market include Rydex Investments, which last month launched six currency-based ETFs, and State Street Global Advisors, which has rolled out six funds, each of which concentrates on one of the following industries: mining and metals; oil and gas equipment and services; oil and gas exploration and production; pharmaceuticals; retailing; and regional banking. It was also announced in June that the Dow Jones Internet Composite Index will be the basis for an exchange-traded fund launched by First Trust Advisors.

"Everybody wants to get in, but nobody's going to bring in another Spider" -- which trades under ticker-symbol SPY -- observes Don Cassidy, a senior fund analyst at Lipper, in reference to the very popular exchange-traded fund launched in 1993 that tracks the S&P 500 (ticker: SPX). With the basic and broad investing themes and benchmarks like the S&P 500 index already covered, firms are rolling out "more exotic varieties" of ETFs, as Cassidy puts it.

Vanguard's Sauter expects some consolidation, because "you just cannot manage an ETF with $20 million" in assets and make any money.

One firm that's trying to break into the game in a big way is WisdomTree Investments, which last month launched 20 ETFs. Among the notable names behind the funds are Jeremy Siegel, the Wharton finance professor who serves as the firm's senior investment-strategy adviser, and Michael Steinhardt, the hedge-fund stalwart, who is chairman. The firm eschews using market-cap-weighted indexes, favoring instead what it calls a fundamental approach with weightings that hinge on cash dividend yields. The bigger dividend-yielding companies fetch bigger weightings.

The common rap on indexes like the S&P 500 is that they overweight the expensive stocks and underweight the cheaper names.

WisdomTree isn't the first firm to favor a fundamental indexing approach. Rob Arnott of Research Affiliates in Pasadena, Calif., has developed an indexing framework using four factors -- book equity value, free cash flow, sales and gross dividends -- on which several ETFs are based.

Why the emphasis on dividends?

Based on Siegel's research, he says, "It was very clear there was a strong relationship between high returns and high dividend yields."

He adds that his research dovetailed with WisdomTree's effort to develop indexes weighted by dividend yields. The firm's marketing literature points out that, from 1926 to 2004, reinvestment of dividends accounted for 96% of the stock market's total return, after inflation.

By focusing solely on dividend-paying companies, the index bypasses some companies, notably those in the technology sector. "During the time when the tech stocks outperform, our index probably would not match the market-weighted indexes," Siegel says.

WisdomTree maintains that back- testing shows that its indexes outpaced those using market-cap weightings. For example, from 1980 to 2005, the WisdomTree Dividend Index had an annual return of 14.71%, versus 12.87% for the Dow Jones Wilshire 5000 Index.

Vanguard's Sauter, widely regarded as an indexing expert, takes a skeptical view of fundamental indexing, opting instead for the cap-weighted approach. He contends that these fundamental indexes tilt toward smaller-cap value names, which have done better than large-cap stocks historically.

"I fear the problem there is that people are being lured into something they think is new and fancy. But, in fact, they are just getting a smaller-cap value exposure," Sauter says.

He also questions "what insures any other approach from overweighting an overvalued stock."

"We don't know what true intrinsic value is," Sauter adds.

Siegel, however, maintains that fundamental indexing is here to stay.

"Fundamental indexing is the next wave of indexing," he says. "My feeling is that it's superior to [market-]cap indexing, and that we will see a migration of assets from cap weighting to fundamental weighting."

WisdomTree's domestic exchange-traded funds sport expense ratios of 0.28% to 0.38% of managed assets; for the firm's international funds, the tab ranges from 0.48% to 0.58%.

Morgan Stanley's Fuhr says that there are still plenty of opportunities for firms to launch ETFs. "It really comes down to the marketing, distribution and management capabilities of the people launching the products," she says.

THE SECOND QUARTER was for the most part lousy for ETF performance, reflecting the overall market's weakness. One of the few bright lights: utilities. The iShares Dow Transportation Average (IYT) was up about 4%.

Several of the single-country ETFs posted small gains, including iShares MSCI Italy (EWI), up 0.29%; and iShares MSCI UK (EWU), up 0.25%.

Among the laggards in the quarter were MSCI South Africa, which lost 19.88%; PowerShares Dynamic Building and Construction (PKB), down 17.27%, and iShares Nasdaq Biotech (IBB), off 15.29%.

All in all, a quarter to forget.

ETF INVESTORS HAVE shied away from technology stocks, instead overweighting utilities, materials and energy. That analysis, compiled by Harris Private Bank Chief Investment Officer Jack Ablin, focuses on the SPDR Sector funds.

As of June 20, 27% of the assets in these funds was in the Energy Select Sector SPDR (XLE) -- almost triple the 9.9% in the S&P 500. The other overweighting was in utilities, which have fared relatively well this quarter, and materials.

At the same time, investors in exchange-traded funds are taking a defensive stance, eschewing technology and financials, among others.

Indeed, Ablin believes it's a little early for investors to start ramping up technology holdings: "Clearly, investors are skeptical of tech, but that could create a buying opportunity."

Just not quite yet, in his view.

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-- posted by SteveT

» mitelo - Too Many ETFs?

In response to Too Many ETFs? posted by SteveT:

Thanks for the article. Here is the link for WisdomTree's ETF's They have some interesting products.

http://www.wisdomtree.com/wt_etfs.asp

-- posted by mitelo

» muckdog - Too Many ETFs?

In response to Too Many ETFs? posted by mitelo:

The big issue with the new ETF is low volume. The spread between bid-ask is huge. You could drive a truck through it. That is a big deal. But I like having them. I use Powershares ETF quite a bit in my trading.

-- posted by muckdog

» Normxxx - ETFs Without A Brokerage Fee

ETFs Without A Brokerage Fee
Click here for link to complete article: http://www.forbes.com/finance/2005/08/31...

By Charles Carlson | 3 July 2006

HAMMOND, Ind.— Exchange-traded funds have been among the fastest-growing investment vehicles in the history of the financial markets. Assets in ETFs now stand at around $240 billion— that’s up from zero in 1993, the year the first ETF was introduced— and are expected to hit nearly a trillion dollars in the next five years.

. . . . . . . . . .

ETFs have not only grown in assets, but also in market coverage. Today, there are ETFs that track such well-established indexes as the Dow Jones Industrial Average (amex: DIA— news— people ), the S&P 500 (amex: SPY— news— people ) and the Russell 2000 (amex: IWM— news— people ). There are ETFs that track specific sectors, such as industrial (XLI), health care (IYH) and technology stocks (XLK). There are ETFs that track foreign stock indexes and commodities— even ETFs that track fixed-income indexes.

In short, with few exceptions, an investor who wants to cover virtually every investment style box can do so with ETFs.

From a DRIP perspective, however, the one problem with ETFs is that there has never been a way to buy ETFs directly, without a broker. Yes, some ETFs allow dividend reinvestment once you own the shares. However, up to this point, no ETF permits either direct purchase or optional cash investments directly.

Fortunately, that is about to change. Nasdaq Global Funds recently announced that it is working to allow investors to buy shares of its Nasdaq 100 (nasdaq: QQQQ— news— people ) index ETF, also known as the "Cubes,” directly, without a broker. The program, which Nasdaq hopes to have up and running shortly, seems to be fashioned after traditional direct-purchase plans.

Under the proposed plan, investors will send investments to an entity hired by Nasdaq (probably a transfer agent), where the money will accumulate and eventually be invested on behalf of investors. According to a Nasdaq spokesperson, the fees are expected to be in the $1 to $2 range for purchases in the program.

If the pilot program with the Cubes is successful, it could be expanded to include other Nasdaq ETFs that invest in American depositary receipts (ADRs) of international company shares.

. . . . . . . . . .

You can rest assured that if Nasdaq’s pilot program is successful, you will see other ETF sponsors (prominent exchange-traded fund sponsors are Barclays (nyse: BCS— news— people ), State Street and PowerShares) follow suit and create direct-purchase plans for their ETFs.

Such a development would be especially exciting for DRIP investors since it would provide a low-cost and DRIP-like way to invest in such areas as small and microcap stocks, international stocks and even bonds. Stay tuned.

Click here for Charles Carson's list of 34 household names and Hidden Gems That Have Raised Dividends for the past 25 years.

  M O R E. . .

______________


The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.

The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

-- posted by Normxxx

» SteveT - NYSE Addresses Risks of ETFs

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By JANE J. KIM
September 7, 2006; Page D2

The growth in exchange-traded funds has attracted the attention of the New York Stock Exchange.

In a publication expected to be released today, NYSE Group Inc.'s NYSE Regulation unit highlights several questions investors should ask themselves and their brokers before buying an ETF -- a type of mutual fund that trades on an exchange like regular stocks.

The publication, the latest in a series of "Informed Investor" pieces, is an educational effort and wasn't the result of investor complaints or concerns over the way ETFs are sold, says Allison Bishop, head of NYSE Regulation's risk-assessment unit. Rather, the exchange says it decided to address some of the "distinct risks" associated with investing in ETFs given the growth of the market and the fact more individual investors are exposed to ETF investment opportunities. "People are comparing ETFs to mutual funds," she says. "That's why we think it's important for people to understand some of the finer details associated with ETF purchases."

The release of the publication, called "What You Should Know About Exchange Traded Funds," comes at a time when ETFs are soaring in popularity and firms are rolling out more versions. Assets have swelled to about $336.92 billion in July, from $65.6 billion at the end of 2000, according to the Investment Company Institute, a trade group. The number of ETFs has jumped to 268 from 80 over the same period.

But the growth of the market also raises concerns about risks and costs.

While the annual expense ratios can be low, investors pay trading commissions each time they trade an ETF, which can drive up investment costs over time. Morningstar Inc., which started rating ETFs earlier this year, notes average annual fees for equity ETFs are 0.43%, while equity mutual funds average 1.45%. For investors who plan to make smaller investments on a regular basis (instead of making one large purchase), investing in a commission-free mutual fund might be less expensive, according to the NYSE publication.

The proliferation of ETFs tracking narrow segments, such as commodities, also can lead to higher costs for investors. These ETFs typically are more volatile, and investors may be tempted to chase performance, which can rack up transaction and tax costs, says Dan Culloton, a senior fund analyst at Morningstar. "The initial appeal [of ETFs] was the ability to get broad diversification at a lower cost in a tax-efficient vehicle," he says. "The further you get away from a diversified basket of securities to finely slice and dice segments of the market, the more you sacrifice the low cost and the more you sacrifice the tax efficiency."

Write to Jane J. Kim at jane.kim@wsj.com

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-- posted by SteveT

» SteveT - In Need of Pruning?

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Growing to the Sky
By THOMAS D. SALER

INVESTORS BEHOLDING THE VAST, varied universe of exchange-traded mutual funds might easily feel as if they've entered a greenhouse whose gardener has long since bolted: The profusion of flowers is striking but overwhelming.

Even excluding the dozens of ETFs in registration, 67 new exchange-traded funds have bloomed this year, bringing their total to 268, a nine-fold increase since 1999. Over the past 12 months, domestic ETF assets climbed 33%, to $337 billion, up from just $83 billion in 2001.

"They have become extraordinarily popular," says Lee Kranefuss, CEO of industry behemoth Barclays Global Investors iShares, which launched its first exchange-traded fund in May 2000. "More assets went into iShares in the first half of 2006 than into Vanguard index funds," he says.

But, as with so many of its successes, there are questions about whether Wall Street has gotten ahead of itself in producing so many types of ETFs that investors get confused and lose sight of the product's inherent benefits. In May, Barclays -- viewed as a conservative indexer -- introduced 10 ETFs based on Dow Jones sub-indexes tracking industries like regional banks, medical devices and broker-dealers. Last year, PowerShares Capital Management launched an ETF that tracks something called the Lux Nanotech Index. Does that square with ETFs' promise to offer investors diversification?

It's a tough question. Consider that the handful of industry groups making up a major sector typically produce a wide array of returns. This year, the Dow Jones U.S. Telecommunications Industry Group is up 23%, a head-in-the-oven, feet-in the freezer average that masks a 34% romp in fixed-line telecom stocks and a 7% drop in mobile telecom issues. Is it better to accept the overall telecom return or chase fixed-line's big gains, knowing it's possible you'll pick mobile stocks instead?

THERE'S LESS DEBATE about ETFs' appeal and their advantages over traditional open-end index mutual funds. They can be traded throughout the day, which lets investors pounce on favorable developments. They also can be purchased on margin or shorted from any brokerage account, and carry virtually no past-tax baggage. On the downside, trading ETFs produces transaction costs and triggers tax consequences.

Exchange-traded funds track an index -- or at least what the fund provider calls an index. Unlike closed-end funds, ETFs create and redeem shares continually, thus keeping their market price closely tethered to their net asset value. That can be important to investors, since buying at a premium -- or selling at a discount -- to the underlying value of the stocks in the fund substantially affects returns. In theory, big disparities between the two prices -- which occur often at closed-end funds -- are quickly closed by arbitragers at ETFs.

"In normal market environments, they will track quite precisely," notes Gus Sauter, chief investment officer for Barclays rival Vanguard. "It is only when there is market-breaking news that there might be a price discrepancy lasting for five or 10 minutes."

WITH ROUGHLY 120 funds and more than $200 billion in assets, iShares is the industry's leader and its approach, like that of Vanguard's, is plain-vanilla: Most iShares are based on popular, broadly based equity and fixed-income benchmarks from S&P, Russell, Dow Jones, MSCI, Lehman and Goldman Sachs.

"The benchmark is very important, because that's what you're buying," says Kranefuss. "Diversification has always been one of the great benefits of indexing, and some people use ETFs as the core of their portfolio."

Vanguard's ETFs (formerly called VIPERS) follow a similar, broadly diversified benchmarking strategy. They are further known for their minuscule expenses, extreme tax efficiency and low tracking error to their benchmarks..

In light of the untrammeled growth of ETFs, you might think there would be a tangle of similar products. But aside from some duplication of a few popular benchmarks, most ETFs track different indexes, a seemingly small distinction that occasionally makes a big difference in returns. For instance, the iShares large-cap growth ETF (ticker: IWF) based on the Russell 1000 benchmark is up about 16% over the past two years while its large-cap growth ETF (JKE) tracking a Morningstar bogy has gained just 8%.

ONE VARIATION on the typical ETF theme comes from ProShares. In July, it launched 12 ETFs that provide magnified upside and downside exposure to four popular indexes. The money-management firm, whose portfolio managers also oversee similar open-end fund offerings under the ProFunds moniker, attracted $1 billion to its ETF lineup within just 11 weeks and has 66 more ETFs in registration.

Of course, leverage works both ways. "Just like any investment, you should know what you are doing," says Michael Sapir, CEO of Bethesda, Md.-based ProShare Advisors, part of the ProFunds Group. "These funds are designed principally for institutional investors, financial professionals, and sophisticated individuals. We are not looking to sell these to mom and pop investors," he says.

Leverage and shorting aside, Sapir sees little difference between levered or inverse ETFs and mainstream varieties. "If you go into a small-cap ETF because you think small-caps are going to do well, you could just as easily go into an inverse large-cap ETF because you think large-caps are going to do poorly," he explains. "Whenever you invest, you are making a judgment call."

Not surprisingly, Vanguard isn't comfortable with the recent trend towards niche ETFs and won't play along, says Sauter. "We're trying to create good long-term tools for investors or their advisers," he says. "We're not trying to create what is likely to be more of a timing vehicle than anything else."

IF VANGUARD ETFs represent indexing purity, then PowerShares' approach might be considered heresy. The suburban Chicago firm, now part of money management giant Amvescap, offers 24 "Dynamic" exchange-traded funds based on what it calls intelligent indexing, or Intellidex. Its computers crunch 24 quantitative factors encompassing four areas (fundamentals, valuation, risk and timeliness) to generate a list of stocks considered likely to outperform the benchmarks from which they are drawn.

You might wonder how an index fund can outperform its own benchmark.

"We want to provide the same exposure as the benchmark, but we use securities that have the highest investment merit rating to represent that portion of the market," says Bruce Bond, PowerShares president and CEO. Though investment merit is in the eye of the beholder, the company's two oldest such ETFs -- Dynamic Market (PWC) and Dynamic OTC (PWO) -- each handily beat its benchmark since inception in May 2003. Bond says the 100-stock PowerShares Dynamic ETF portfolios minimize the risk that one or two errant picks will seriously undermine performance by strictly adhering to benchmark sector and capitalization weightings.

Though a computer may be calling the shots, the PowerShares Intellidex ETFs are a bit of a hybrid: They closely resemble actively managed funds. "They have a lot of similarities," admits Bond. "The real difference is that our indexes are transparent -- you know exactly what you own every day, whereas active managers only show their securities on a quarterly or monthly basis."

While some at PowerShares are edging toward more active management of a passive, indexed product, others are working on new types of indexes.

In September, PowerShares launched 10 sector ETFs that track so-called fundamental benchmarks. Unlike their capitalization-weighted counterparts, the fundamental indexes (which track FTSE RAFI benchmarks) reflect a company's economic size, not market value. The PowerShares indexes are rebalanced annually, making them a hybrid of passive and actively managed ETFs. And though the cap-weighted versus fundamental debate might seem like fodder for academics, Bond notes that such a distinction would have prevented investors during the technology bubble from holding Internet shares whose market capitalization grossly exceeded their economic "footprint."

Other new ETFs are reasonably straightforward, yet provide access to previously untrod areas. In November 2004, another indexing giant, State Street Global Advisors, launched streetTRACKS Gold Shares (GLD), the first ETF tied to the price of gold bullion, and Barclays followed with iShares COMEX Gold Trust (IAU) and iShares Silver Trust (SLV). For better of worse, ETFs also have allowed investors into off-the-beaten-path businesses like water resources and clean energy.

THE WILD GROWTH of ETFs surely could be an indication that Wall Street's marketing machine is better at dispensing products than wisdom. After all, few analysts can predict a market's direction with any more accuracy than a coin flip could. And these niche ETFs give even more investors of all sophistication levels the means to bet on micro-trends whose outcome is nearly impossible to foretell.

That's not to say all of these bets increase risk. "Very often ETFs are used by professional investors as a hedge to minimize risk, as opposed to using them to swing for the fences with a narrow basket," says Barclay's Kranefuss.

Debbie Fuhr, an ETF specialist with Morgan Stanley, thinks that most -- though not all -- of the recent product launches are market driven. "As long as they are based on demand from clients, then it's fine," she says. "But sometimes people are just developing new and innovative products that may be a little ahead of their time."

Whether these products continue to flourish by helping investors or simply entangling them with endless variations will depend on how carefully they're nurtured. "When you create too much flexibility, it's possible some people could hurt themselves with it," says Vanguard indexing guru Sauter, "but I don't think it's mandatory."

Still, a little prudent pruning now and again can only help.

THOMAS D. SALER is a free-lance writer in Madison, Wis.

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-- posted by SteveT

» SteveT - The ETF Challenge

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By LAWRENCE C. STRAUSS

EXCHANGE-TRADED FUNDS IN THE U.S. have grown to about $350 billion, continuing a rapid expansion. That's still tiny compared with the $9 trillion-plus mutual-fund industry. Nonetheless, ETFs, as they are known, are becoming a more popular alternative to traditional index funds.

Case in point: The Vanguard Group, which brought indexing to the masses 30 years ago, reports that 25% of its cash flows into index funds this year, through Aug. 31, is going into exchange-traded funds.

Is this part of an overall shift away from traditional index funds into ETFs?

Definitely not, says Gus Sauter, chief investment officer at the Vanguard Group. Others disagree, saying it's just a matter of time before ETFs supplant conventional index mutual funds.

Sauter has maintained that ETFs and index funds are variations on the same theme -- indexing -- the key difference being in the distribution. ETFs primarily appeal to institutional traders or investment advisers, he says, adding, "Neither of those segments had been investing in conventional index funds previously."

Sonya Morris, a fund analyst at Morningstar, doesn't expect ETFs to replace the Vanguard Total Stock Market Index (ticker: VTSMX) or others like it, mainly because ETFs haven't made much progress breaking into the 401(k) market. One obstacle is that ETFs are bought and sold like stocks, requiring a brokerage commission. For investors regularly socking away small amounts, the commissions eat into savings, making it an unwise investment.

"ETFs haven't quite figured out how to enter that market," says Morris. "They still haven't gotten around the whole brokerage-commission" issue.

Deborah Fuhr, who tracks ETFs for Morgan Stanley, says it comes down to whether there "is a way to fit ETFs into that window, a way to figure out a cost-efficient way to employ ETFs in those long-term plans."

Fuhr says it is possible to craft a way for ETFs to gain a stronger foothold on 401(k) platforms -- for example, by bundling a company's 401(k) transactions and thereby negotiating lower broker commissions. That would open up substantial opportunities for these funds to grow, she says.

For his part, Sauter doesn't think the ETFs are a natural fit for 401(k) plans, because brokerage accounts are unusual in those savings vehicles.

Brian Reid, chief economist at the Investment Company Institute, the fund industry's trade group, notes that conventional index funds have grown nicely, as well. As of August, those funds had assets of $663 billion, more than doubling from $328 billion at the end of 2002. He adds that these funds, mostly domestic in focus, have held their own compared with the growth of the ETFs.

Others think it's a just a matter of when, not if, ETFs surpass traditional index funds. Gary Gastineau, an ETF expert based in Summit, N.J., points out that ETFs for the most part have lower expense ratios than comparable index funds do, along with tax advantages. And he maintains that actively managed ETFs, which have not been approved by the Securities and Exchange Commission, will prove popular with investors once they are rolled out.

Meanwhile, the Vanguard 500 Index Fund (VFINX) has had net outflows for more than a year. Sauter doesn't attribute this to competition from ETFs. "It's more a story of people becoming familiar with broader market indexing," he says.

Vanguard Total Market Index has had net inflows over the same period.

REFLECTING THE OVERALL MARKET'S INCREASED volatility, exchange-traded funds posted a wide range of results in the third quarter, with energy funds the biggest laggards. Technology funds ended up at the head of the pack.

Annualized volatility of the Standard & Poor's 500 during the third quarter was nearly 11% -- as the stock market stayed volatile early in the quarter after the gyrations of May and June. This is higher than readings over much of the past year.

Most of the worst-performing ETFs tracked by Lipper for Barron's had an energy bent, including the Oil Services HOLDRs Trust (OIH).

Other poor performers in the quarter were Internet HOLDRs Trust (HHH), down 10.17%, and iShares Dow Transportation Average (IYT), off 8.97%.

Some of the other funds covering narrower markets had a tough quarter, too. That includes iShares MSCI Brazil (EWZ), which lost 2.51%. The decline, its second down quarter in a row, takes some of the luster off the ETF's 53% gain in 2005 and its 21.20% rise in the first quarter.

However, many technology ETFs posted strong third-quarter results, including iShares Goldman Sachs Software Index (IGV), which gained 15.57%.

Fidelity has eliminated hourly pricing for its Select funds lineup. The net asset value of the funds, which focus on various sectors, will be calculated once a day, at 4 p.m. EST. A Fidelity spokesman said that intraday trading in the Select funds "was not that different from our other funds."

MORE ON ETFS: IF YOU MISSED my colleague Randall Forsyth's excellent Up & Down Wall Street Daily2 Sept. 15 column from Barron's Online about commodity ETFs, here's an excerpt:

The last shall be first, the Bible says, but on Wall Street it's the opposite. The last to get in are usually the first to be fleeced.

So it would seem with the crop of exchange-traded funds pegged to the commodities market and the price of oil. And that also goes for the newest permutation, exchange-traded notes, which also track commodities and crude.

Commodities have taken a big hit lately, precious metals and energy in particular.

Cases in point: The streetTRACKS Gold Shares ETF (GLD) is down about 15% from its peak in May. And the iShares Silver Trust (SLV) is well off its high, also set in May.

As I noted in Up & Down Wall Street in print earlier this year ("Famous Last Words3," March 27), the long-delayed initial public offering of the silver ETF could mark the top tick for the metal, which had run up in anticipation of vast demand from the public -- and which the pros would obligingly accommodate.

Equally coincidentally, the iPath Goldman Sachs Crude Oil Total Return Index (OIL) exchange-traded notes bowed Aug. 16, not long after crude futures peaked at $78. Since that day, OIL has slid, and the ETN has lost about 20% of its value.

That's not a knock on the ETN structure. ETNs actually are debt obligations of Barclays Bank, which pay a return based on a relevant index, less a 0.75% expense ratio. Barclays also has issued ETNs tied to the iPath GSCI Total Return Index (GSP) and the Dow Jones-AIG Commodity Index (DJP), both devilishly dated 6/6/06. The Barclays ETNs trade on the New York Stock Exchange like stocks or ETFs.

While commodity-based ETFs are taxed as a "collectible," at 28%, ETNs should be taxed at capital-gains rates, according to Barclays. The bank's Website avers that the Internal Revenue Service "may assert an alternative treatment," but without a ruling to the contrary, ETNs ought to be taxed at cap-gains rates of 15%.

Clearly, the proliferation of instruments offering exposure to commodities to investors who can't or don't want to trade futures or options is just the most recent example of Wall Street's willingness to market the latest hot concept to the public. And, as usual, the hoi polloi usually jump onto the end of the bandwagon.

But the public doesn't seem to be jumping off, at least in the case of gold. Trey Reik, co-manager of the Apogee Gold Fund, a hedge fund specializing in gold shares, points out that the streetTRACKS Gold Shares have continued to see inflows even as the bullion price has been trending down recently.

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-- posted by SteveT

» pauljwest - Yield Question

Hi All ...

Pretty new to this stuff.. but I have a question about ETFs and yield.

I am looking at ETF "BHH" ... in the WSJ it shows a yield % of over 8 .... Can someone please explain this number to me ... surely BHH which is 75% invested in Checkfree does not have a yield dividend of 8%.

thanks for your help
Paul

-- posted by pauljwest

» pauljwest - BHH Yield Question - HOLDRS B2B Internet (BHH)

In response to BHH Yield Question - HOLDRS B2B Internet (BHH) posted by Kirk:

THanks Kirk..... I knew it wasnt legit... googled for about 4 hours trying to find out why....No luck...

Good luck to ya,
Paul

-- posted by pauljwest

» SteveT - China Funds' Shell Game

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By LESLIE P. NORTON

SO YOU'RE THINKING OF TAKING the plunge and investing in China, but you don't feel capable of choosing the stocks. Not to worry: An obvious solution is exchange-traded funds, right? Not so fast. If you chose to invest in the iShares FTSE/Xinhua 25 index fund (ticker: FXI), you'd be up 37% this year. But if you invested in PowerShares Golden Dragon Halter USX China (PGJ), you'd be up a very respectable but less stellar 20%.

Why the big performance spread?

The two funds include different holdings. The iShares fund, based on an index of the 25 biggest and most liquid mainland companies traded in Hong Kong, has a big slug of financials and telecoms, including popular Chinese bank stocks traded only in Hong Kong. It has $3.1 billion in assets.

The PowerShares Golden Dragon fund is based on the Halter USX China index, and owns 54 U.S.-listed companies that do the bulk of their business on the mainland and have an average market cap of at least $50 million for the preceding 40 trading days. Thus, it owns the big U.S.-listed Chinese stocks, and some Internet shares like Baidu.com (BIDU) that shunned Hong Kong listings entirely. (An open-end mutual fund, Halter Pope USX China Fund (HPCHX), mirrors it, too.)

PowerShares maintains that its fund is preferable because its companies are listed in the U.S. and therefore must file quarterly reports with regulators. This argument apparently carries some weight with investors, because the fund has $250 million of shares outstanding.

That said, there are some issues surrounding the Golden Dragon fund. Some of the stocks that haven't done well have ties to Timothy Halter, who started the index in October 2003. The 40-year-old Dallas native and his advisory company, Halter Financial, are among the leading proponents of reverse mergers. These are back-door listings in which privately held companies become public without filing a prospectus or undergoing an IPO. The private company's owners receive shares in the new entity in the exchange. Armand Hammer invented the reverse merger in the 1950s, when he merged Occidental Petroleum with a shell company. Proponents of reverse mergers say they're cheaper and simpler than IPOs; critics, however, contend that their regulation is more lax.

Halter claims to have been involved in more than 50 reverse mergers since 1987. In fact, if you type reversemerger.com into your browser, you get his site. Halter maintains an inventory of public shells and takes shares in the new company in return. He's also trademarked the term "Alternative Public Offering."

Halter has ridden the wave of Chinese reverse mergers. Since 2000, about 100 Chinese companies have come public in the U.S. via reverse mergers. Today, they have a market cap of more than $7 billion. In March 2003, Halter took public China Automotive Systems (CAAS), which supplies power-steering components; today, it's listed on Nasdaq and has a market value of nearly $190 million. The following September, it was Tiens Biotech (TBV), which makes nutritional supplements and skin-care products; it now has a market cap of $234 million and is listed on Amex. In January 2005, China BAK Battery (CBAK), which makes lithium ion batteries, followed this route; it has a market value of $334 million and a Nasdaq listing. Halter's firm also took public Zeolite Exploration, Zhongpin, and Wonder Auto, all traded on the bulletin board.

China Automotive, China BAK and Tiens Biotech were sufficiently successful that they were included in Halter's index. And therein lies the rub. With the exception of China Automotive, whose 20% gain this year matches the index's rise, many of Halter's reverse-merger stocks haven't done much and are well off their highs.

Barron's review of the index unearthed conflicts that ought to give fund investors pause. The shares of at least one of these companies rose in value after entering the index, but as the stock gained, Halter and his family were selling.

These questions arise amid warning bells about Chinese reverse mergers. For instance, China Energy Savings Technology (CESV) was suspended from trading last month as the SEC questioned "the accuracy and completeness' of the company's filings, particularly the ownership of its sole asset and "the existence and/or identity" of the company's chief executive; the Halter index dropped China Energy Savings last quarter.

Denise Voigt Crawford, the Texas securities commissioner, is a critic of reverse mergers. Generally speaking, she says, "It really is so easy for reverse-merger companies to manipulate the price of the shares and get around the criteria applied. There's a great deal of interest in China. That makes it ripe for con artists." Crawford wrote a complaint to the SEC from the North American Securities Administrators Association two years ago about reverse mergers and Chinese reverse mergers in particular.

There's no hint that Halter's reverse-merger companies in the index are anything but legitimate and they make up just a small part of it. But the tactics of one constituent might raise questions for investors. Consider China Automotive, which Halter took public in a reverse merger in March "03. That fall, China Automotive hired investor-relations firms to help promote its stock. One was Dallas-based Insight Communications, which had a subscription-only investment group called the China Club that publishes the China Dispatch monthly newsletter, and the other was Vancouver-based NAI Interactive.

J. Michael Casson, founder of the China Club, explains that the idea for the Club grew partly from a brain-storming session about investor-awareness campaigns for Halter's companies; his contract lasted just three months, Casson says, and his newsletter proceeded to tout China Automotive until the second quarter of 2004. NAI Interactive was hired for 12 months in October 2003 to provide publicity and investor relations for the company; it also publishes a newsletter, compiles an NAI China Small Cap index (which China Automotive was added to), and holds conferences called "The Global Chinese Financial Forum." Reads one testimonial on its Website: "Impressive work done by NAI Interactive!" The source: Timothy Halter.

In the fall of "03, the shares of China Automotive rose, before sagging the following spring. By August "04, they gained further amid news of a venture to produce automobile sensors and later, to supply steering pumps for General Motors. A blizzard of favorable releases accompanied the stock's ascent. According to Bloomberg reports, Halter Financial sold shares in China Automotive a week before the firm announced that its application to list on Nasdaq was approved. On Oct. 12, 2004, the Halter USX China Index said it would include China Automotive. The same month, China Automotive officials presented at an NAI conference and a lunch for high-net-worth investors. A week later, Halter's brother Kevin also sold China Automotive Shares. Around Nov. 22, Halter Financial sold again. The shares subsequently ran as high as 16, before collapsing in December. Recently, they traded at 8 and change.

There's an inherent conflict of interest between investment managers and those who take companies public, which is why investment banks, ironically enough, erect Chinese Walls. The reason: investment managers have fiduciary duties to investors, while investment bankers' job is to sell stocks that generate fees and trading commissions. Thus, Halter's China index has a separate, four-member selection panel for the index -- and a different address.

However, some of these relationships don't appear to be at full arm's length. For instance, the mailing address supplied on the Website for the indexes is the same as that of Halter Capital, a financial-services firm owned by Halter's father and his brother, Kevin Halter, and Kevin Halter Jr., which also maintains an inventory of shells for reverse mergers. In 2005, the elder Kevin's wife Pam and Kevin Jr. served as directors of a firm now known as Zhongpin, one of Timothy Halter's reverse mergers. The junior Halter, who didn't return phone calls, also runs the transfer agent used by many of Timothy's reverse mergers.

Timothy Halter said he didn't how the shared addresses came about and that there are "no involvement or ownership" arrangements with his brother's firm. (By Friday of last week, the Website no longer carried the address.)

One of the four index-selection committee members is Joseph Mannes, who once served on the board of Karts International, a go-kart maker whose chairman was Timothy Halter. In 1999, Karts International was delisted. Today, Mannes is a managing director at Samco Capital, a Dallas broker-dealer. He's also on the board of China BAK Battery, whose shell Halter owned before taking the company public in a reverse merger.

Another committee member is Stephen Sun Chiao, a professor of electrical engineering at San Jose State University and a managing partner at Sycamore Ventures, a venture capitalist. Chiao appeared as a selling shareholder of China BAK in December, along with Halter Financial.

This year, shares of China BAK are down 38%. The company announced in August that it fired its auditor and would restate three years of financials. It's also being sued by the University of Texas and power supplier Hydro-Quebec for infringing patents covering a line of batteries the company makes for DeWalt tools.

Many had expected sales to DeWalt to drive China BAK's growth. Among those who've registered to sell China BAK shares in the past year: Halter Financial, Kevin Halter Jr., and Pinnacle China, an investment partnership of which Timothy Halter is a founder. Timothy Halter says that he doesn't manage Pinnacle China or the Halter Pope open-end mutual funds, so "there can't be a conflict of interest."

Mannes, who's been with the Halter index since the start, says that rules have been created to address his conflicts of interest: He can't vote on any issues related to China BAK Battery, whose shares he also owns. "That's something we had talked about initially. It became an issue," and so the rules were changed, says Mannes.

Chiao has been on the index committee for over a year. He describes the selection process as "very mechanical." He owns China BAK shares, he acknowledges, and has cut his position by a third. As for Timothy Halter: "Tim and his brother strike me as very professional in terms of understanding the China landscape. They are rather patient and have very good relationships with several hedge funds in the U.S."

Of the index-creation process, Halter says, "It's an index. There's absolutely no subjectivity whatsoever to listing companies. [Mannes and Chiao] are investors in China BAK, but it still easily meets all the selection criteria."

As for the other Halter shares in the index: Tiens Biotech is down 9% this year amid weaker-than-expected second-quarter results. The fund's other reverse-merger shares, which were not brought public by Halter, are educational-software outfit Intac International (INTN), up 20%, and electronics designer Comtech Group (COGO), up a whopping 140%. And last month, the committee approved Origin Agri-Tech (SEED), which was taken public by a special-purpose acquisition company called Chardan China. Origin was nearly four months late filing its December 2005 annual report, announced a major change in revenue recognition, changed to a September fiscal year and late last week fired its auditor.

Says Halter: "Whether or not to invest in Chinese companies that go public through a reverse merger is not the question. You're seeing large, sophisticated institutional investors participating in this. The question is whether China is a good place to invest."

Adds selection-committee member Mannes: "This is a challenge. With a wonderful market like this, you're going to have volatility. The sheer increase of names means stuff is going to happen."

That's an undisclosed risk that PowerShares investors may want to consider.

The Bottom Line
Securities regulators have raised warning signs about Chinese companies that have undergone reverse mergers, and investors are well advised to tread cautiously.

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-- posted by SteveT