ETF growth in the US

Any British investors looking to get a handle on the way that trackers are likely to develop should take a look at the US where the whole ETF scene is absolutely huge. And it's still growing. I've reproduced a small article below from Tom Lydon of Seeking Alpha that discusses how fast the sector has bene growing in the US in recent months....and remember that what starts in the US eventually finds it way to the UK...

According to Lydon:

'The total number of ETFs was 542 as of the end of June, and 162 of those were launched in the first six months of this year, according to Scott Burns for The Dallas Morning News . Oodles more are on the way. To get an idea of how fast this industry is growing, Burns looks to the history of mutual funds and index funds for comparison:

• It took mutual funds 56 years before they reached the same number ETFs have in 14 years.
• It took index funds 25 years before their numbers reached 542.

With so many new ETFs on the way, they will enter a market already overflowing with choices. More options provide investors with more opportunities to find ETFs that match their financial goals. However, this also means that investors will have to do more research to understand the differences among all the ETFs. In a world with better educated investors, everyone wins.

By 2011, total assets under management globally in ETFs are expected to surpass $2 trillion, which is up from $669 billion as of June 30, according to a report by Morgan Stanley. Some possible causes behind the growth, according to Pensions & Investments for Investment News , include:

• ETF expansion into new sectors and regions
• Larger allocations by U.S. and European investors
• Managers increasing the number of products brought to the market

The U.S. has the most active ETF market with 1,559 institutions using ETFs, as of Dec. 31 last year.'

What should trackers track?

The point about trackers is that they track indices - which is why some people call them index trackers. But what happens if the index you’re tracking is not real but made up by the investment provider ? Proper indices are at the very least based on market capitalisation (they reflect Mr Market and his trading actions) or on a set of key fundamentals. Barclays are pioneering a hybrid approach to tracker or passive investing - they're establishing their own basket or index of shares which they then track. The problem here is that you’re relying on Barclay's judgement of which shares to track:

Are they the right set of shares?

Should they be based on a consistent fundamental criteria and should the relative weighting be base don market cap?

The answer with these products from Barclays is that they've kept it simple - ten banks, equally split - but this all smells of almost active investing - you're paying the investment adviser to make the judgment call not betting on the market. This is particularly acute as the ten shares listed on the note does not include Barclays itself - if you are going to adopt an active approach to picking shares then we think that Barclays itself is probably one of the best investment bets at the moment!

Bottom line-

Is it currently a good investment? Probably.

Is it a good investment idea? We have our doubts.

Leading global banks - Barclays

Barclays continues to issue investment notes that track key sectors. Their latest product (which we have briefing note on ) tracks ten of the worlds leading global banks.

There's the usual capital guarantee plus you get 160% of the upside of the ten shares. We think given the recent market turmoil, that this could be a stomping good investment BUT - and there's a big but coming - we're not too sure about the investment concept at work here. [See later message on ‘What should trackers track?’]

Capital Accumulation IV Shares – Merrill Lynch

Merrill Lynch have just launched a weird structured product. It's called rather inelegantly the Capital Accumulation IV Shares and is a straight bet on the Japanese TOPIX index over-taking the US S&P 500. If at any point over the next three years the TOPIX overtakes the American index the fund winds up and you get a fixed payout. That fixed payout goes up over time - if it happens before Christmas 2007 you get 112p a share (against an issue price of 100p) whereas if it happens after then but before mid June 2008 you get 124p. Every six months after then you get an extra 12p per share up to a maximum payout of 84p at redemption. It's a remarkably weird product – it’s a bet on the relative out-performance of the Japanese markets but it could be a huge winner.

European Carbon Emissions trading index - Xshares

Xshares has just launched stateside an ETF that tracks the European Carbon Emissions trading index. It's a genius idea (although the index itself is a bit odd) and could make a brilliant long term , non-equity correlated, investment.

Charges on the rise?

It looks like all the recent innovation seen with trackers will cost you money!

The new SocGen products (see "Four new Green trackers from SocGen" below) charge a princely 1% in management fees plus a 1% initial bid offer spread. Breaking the 1% barrier is a rather disappointing innovation (except of course in the conventional unit trust sector where 1% plus fees are sadly common). I have no doubt that the currency hedging at the heart of the SocGen note costs money but 1% is a little excessive and simply wouldn't fly in the more competitive US space. A fee of 0.75% for a specialist fund should be tops and one only hopes that as competition intensifies, that 1% charge will be forced won.

Green Trackers - let battle commence

It's clear that the new battle ground for trackers is over all things green - everything from water utilities through to bio-ethanol suppliers are being targeted by new tracker launches. I'd expect more counter-strikes from iShares and maybe some more conventional issues from Lyxor. Beyond this I'd predict that the new big theme will be socially responsible investing more generally - look out for CSR launches that look beyond green stocks and target the whole ethical space.

Four new Green trackers from SocGen

SocGen has just kicked off its new listed structured product programme with four new 'Green' trackers that follow everything from uranium through to solar power.

SocGen is gearing up to launch a series of these tracker notes - effectively structured products that act like ETFs but are actually structured as secured notes on an index. Further info: www.sgindex.com.

This web site also hints at a broader ambition by SocGen - to issue a massive range of funds that will take everything from hedging strategies to investing in defense companies. If you look through the list you'll see some very interesting potential funds, most notably an index that covers the call writing options strategy on the S&P500 which I think would be a huge innovation. There's also interesting strategies that target the global super rich and the golden oldies demographic; although some of the indices used to track these changes strike me as a little off the beaten track to put it mildly. Still full marks for imaginative ideas

SocGen 10 Year Multi Asset Tracker

Does managing a pension portfolio confuse and agitate you? Worried by all the choice, confused by the asset classes, panicky that you’re just not in the financial asset allocation loop? The answer may be at hand – and no, it’s not a sedative or some form of ketamine.

Step forward instead a really obscure structured product certificate from SocGen called SG10 or the 10 Year Multi Asset Tracker. Basically it’s DIY asset allocation made simple for the confused investor.

Here’s how it works.

Launched last summer to the doyens of the private wealth market, it invests in a wide range of markets and asset classes via structured products – the exact mix for this year is in the table below. 12% for instance goes into a FTSE 100 tracker (maybe the Lyxor product?) while 30% for instance is invested in a global bond index (the wonderfully acronym encrusted SSGWGBI Index).

All in all there are 11 asset classes, including hedge funds, and you get 100% of the return from holding this mix of indices, with annual rebalancing but with no additional fund manager charges. Oh yes, and if you hold the product for the full 10 year term, you get £1000 in capital back even if the final mix of classes has fallen. Call it asset allocation for dummies on the cheap.

The downside – and yes, there’s always a downside – is that like all structured products you don’t get the dividend income from holding the index which with bonds is fairly substantial plus there’s a 1.5% bid/offer spread when you buy the shares.

Still for many investors those disadvantages might be worth it , especially when you consider the fact that you get all the hard work of asset allocation done for you relatively cheaply. But the key is whether the mix makes sense – SocGen have tried to answer this in a backward-looking way by examining returns over the past few years which produced compound annual returns of between 4.25 and 6.3%.

At first sight these may seem a bit low but bear in mind the cautious, absolute returns based nature of the mix – there’s a lot of bonds and hedge funds that pay out a bit over cash. These asset classes also haven’t done very well in the last year which also helps explain why the product is currently down 10% on the year but the key is to compare this with other absolute return products with a heavy mix of bonds and hedge funds.

Summary

The 10 Year Multi-Asset tracker is a product worth exploring if you want a cautious approach to investing over the next ten years – but one to avoid, if, like me, you’re much more aggressive about equity investing and think that shares are worth the risk.