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It is getting slightly less crowded in the land of exchange traded funds. ETFs - baskets of securities designed to track indices and trade like stocks - have been the investment industry's most successful product innovation in recent years, but 2008 has got off to a slow start.
According to a recent report by Morgan Stanley, there are 645 ETFs on the market today. In 2006, 154 new ETFs made their debut; last year, that number was 271. But only five new ones were launched in the first two months of this year, according to the latest statistics from the Investment Company Institute.
In spite of the slowdown in new issues, asset flows have remained relatively robust. ETF assets are about $560 billion today, compared with $430 billion a year ago. The market is skewed toward the larger players: the lion's share of assets - 75 per cent - are held in the 50 largest funds, while 135 ETFs have less than $10 million in assets and 80 have less than $5 million.
Paul Mazzilli, director of the ETF research team at Morgan Stanley, predicts assets will continue to grow at 25-35 per cent a year, but, he adds: "The number of new listings will continue to slow because there is less start-up capital available, and most market segments are already covered.
"A lot of [new products] have been of the 'me too' variety. They have been brought out by fund groups that don't have a lot of marketing clout. They just stagnate."
But ETF innovation is hardly doomed, he says. In particular, newly launched fixed income and international funds have been successful. "Products that are timely and satisfy pent-up investor demand have done well," says Mazzilli. "The right products are going to get assets."
Take, for instance, WisdomTree's India ETF - the first such fund to cover the country. The fund, which is weighted by earnings, launched in February, and now has $163 million in assets.
State Street Global Advisors has done well with global, fixed income-based ETFs. Its International Government Inflation-Protected Bond ETF, which includes 120 inflation-indexed bonds from 18 developed and emerging countries outside the US, launched in March, and has $72.5 million in assets.
SSgA launched an international treasury bond fund in October that has also seen strong flows. The ETF, designed to provide low-cost access to international fixed income - an asset class that historically has had a low correlation with the US equity and bond markets - today has $750 million in assets.
Survey
"When we looked at the investment landscape, we could see that investors, one, want to diversify away from the dollar and, two, are scared about inflation," says Jim Ross, a senior managing director at SSgA.
Barclays Global Investors has also made a splash in fixed income. Last September it introduced the S&P National Muni Bond ETF, which gives investors an opportunity to place low-cost bets on the $2.400 billion US municipal bond market without directly owning individual bonds. It has seen steady flows, and today boasts about $562 million. Meanwhile, Barclays' California Muni Bond ETF - launched in October with about $40m in assets - today has $70 million.
"There has been a growth in investor awareness and adoption of these ETFs," says Matt Tucker, head of fixed-income investment solutions for BGI's iShares business. "In some ways it was a good time to launch the product. Investors view the ETF as the more transparent, less risky way to access the market."
Northern Trust, one of the biggest institutional asset management companies in the US, is also getting in on the action by introducing a new line of international ETFs. In April, it launched six funds that track some of the world's best-recognised equities indexes. The funds include the Hong Kong Hang Seng Index Fund and the UK's FTSE 100 Index Fund.
According to Steven Schoenfeld, the company's chief investment officer, these represent the "crown jewels" of indexing. "In devising our entry strategy, we wondered what we could bring to the market that investors would accept and applaud. It doesn't make sense to burden the ETF infrastructure with another 'me too' product," he says. "We're bringing global markets to the US time-zone."
Northern Trust has also registered with the Securities and Exchange Commission to launch similar ETFs from other large, developed markets such as Italy, the Netherlands and Singapore, as well as medium-sized markets such as Belgium, Portugal and the Republic of Ireland, and emerging markets including South Africa and Thailand.
But product innovation goes beyond the realm of fixed income and international. ProFund Advisors, a money manager that has carved a niche in the fund management industry by providing mutual funds with leveraged short and long attributes, in March brought out two ETFs that enable investors to go long or short on the telecoms industry.
Pipeline
Rydex Investments also plans to introduce new inverse and leveraged funds later this year. "Because of existing market conditions people have gravitated toward the inverse funds," says Tim Meyer, managing director of Rydex ETFs. "But there are always going to be some sectors that start to perform, and we could see assets shift from inverse to long leverage."
Other fund companies are launching industry-specific ETFs. Claymore Securities last month launched an ETF designed to mirror the MAC Global Solar Energy Index, which tracks companies that produce solar power equipment and services. The ETF now has assets of more than $50 million. Most of the portfolio - 72 per cent - comprises companies outside the US, with China and Germany the biggest regions represented.
Christian Magoon, president of Claymore's ETF division, says the fund should appeal to retail and institutional investors. "Retail investors and financial advisers are looking for a diversified approach to the next generation of energy, and, from an allocation perspective, they want a hedge on their fossil-fuel stocks," he says.
"Institutions and hedge funds will use the ETF as a hedge for individual solar stocks in their portfolio or to make a solar bet."
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