ETF filings give pause

Nov 20, 2006 @ 12:01 am

By David Hoffman

PHILADELPHIA - Enough, already.

That is what some industry experts and financial advisers are saying in the wake of filings this month by Rydex Investments of Rockville, Md., and WisdomTree Investments Inc. of New York, to bring to market 96 and 31 new exchange traded funds, respectively.

If they receive approval from the Securities and Exchange Commission - and there is no reason to think they won't - the proposed ETFs will be added to the 329 that were in existence at the end of October.

'Lot of excesses'

But that doesn't sit well with some in the industry.

"We don't need all these ETFs," said Paul Schatz, president of Heritage Capital LLC of Woodbridge, Conn. Some undoubtedly will fall by the wayside, he said.

When it comes to too many ETFs, Dan Culloton, an analyst with Morningstar Inc. of Chicago, agrees.

"I would say there are a lot of excesses in the ETF area right now," he said.

The growing number of ETFs makes it difficult for investors to choose the right investment, said Armond Dinverno, a financial adviser and co-president of Balasa Dinverno & Foltz LLC in Itasca, Ill.

"More choice always makes it harder," he said.

Other industry experts, however, don't see the ETF explosion as a problem.

There are more than 22,000 mutual funds including all share classes, according to Jim Lowell, the Needham, Mass.-based editor of the Forbes ETF Advisor, a monthly newsletter.

ETF's haven't even reached "a full round thousand," he said.

"I think there ought to be as many new products as what the markets can bear," Mr. Lowell added.

Just because ETFs are becoming more numerous doesn't mean they won't find an audience, he said.

Competition for that audience, however, will get tougher.

For example, Rydex's filing signifies that there will be many more ETFs that seek a multiple, inverse or inverse multiple of the performance of a particular index fighting for what many industry experts think is a very limited amount of money.

Rydex Dynamic ETFs will seek twice the return of an index; Rydex Inverse ETFs will seek the opposite return of an index; and Rydex Dynamic Inverse ETFs will seek twice the opposite return of an index.

They are very similar to 12 ETFs launched in June by ProFund Advisors LLC of Bethesda, Md., doing business as ProShare Advisors LLC, that use leverage to go long and short their underlying indexes.

Those ETFs already have garnered more than $1 billion in assets, and in September, ProShare registered to offer 66 other such funds. The ETFs for which it registered have yet to be launched.

One firm standing

Considering that such ETFs appeal to only a select group of financial advisers, principally those that do some sort of tactical asset allocation, "it's a lot for not a very big universe," said Mr. Schatz, who is a fan of such funds.

Another proponent of such funds agrees.

"My guess is that in five years … there will be one firm standing," John McClure, president and chief executive of ProfitScore Capital Management Inc. in Boise, Idaho, said about ProShare and Rydex, which specialize in ETFs that go long and short an index.

Which firm that will be is anybody's guess.

Both firms have worked hard to woo financial advisers.

"I have the greatest respect for Rydex," said Harold Evensky, chairman of Evensky & Katz Wealth Management in Coral Gables, Fla. "When I see them doing something, I get interested."

Rydex has been very responsive and helpful when it comes to technical questions, Mr. Evensky said.

But ProShare has, too, Mr. McClure said.

An investor can get an answer from both ProShare and Rydex "in a minute," he said.

"I think both of these firms are bending over backwards to cater [to] the registered investment adviser," Mr. McClure said.

That is a good formula to follow if ETF producers want to survive, industry experts say.

There still is room for new ETFs, but they must be different from what now is available, Mr. Lowell said.

But the problem with offering new and unique products is that success may not be sustainable.

WisdomTree is a good example.

Debate is raging

WisdomTree's ETFs - and its proposed ETFs - follow "dividend-weight indexes" that select securities in each index based on either the amount of cash dividends that companies in each index pay or the dividend yield of the companies in each index.

Having launched its first ETFs in June, WisdomTree already has surpassed $1 billion in total assets.

But not everyone is cheering.

"I think they're fads," Jerry Miccolis, an investment strategist with Brinton Eaton Wealth Advisors of Morristown, N.J., said about WisdomTree's ETFs and others like them.

He has yet to be convinced that ETFs that follow a "fundamentally weighted" index are any better than ETFs that follow traditional indexes weighted by market capitalization.

Mr. Miccolis comments echo a debate that is raging between proponents of market-cap-weighted indexes, such as John Bogle, founder of The Vanguard Group Inc. of Malvern, Pa., and proponents of fundamental indexing, such as Jeremy Siegel, a finance professor at The Wharton School of the University of Pennsylvania in Philadelphia, who wrote the best-selling "Stocks for the Long Run" (McGraw-Hill, 1994). Mr. Siegel also is the brains behind the WisdomTree indexes.

Such controversy, however, won't slow down the pace of ETF production, Mr. Lowell said.

Investors can expect to see still more ETFs in the near future, he said.

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