I’m surprised that it’s only now that we’re starting to hear the term “contagion” used more often in the financial press about the current predicament seen globally and especially in the US. Over the past couple of years, I’ve mentioned in passing to different people my concerns regarding the economic outlook of the US. The way I see it, the typical American consumer (”super consumer” may be more appropriate) who is feeling the noose tighten from their mortgage obligations could soon make decisions that would have an effect on other forms of credit. Car payments are one area. We’ve seen GM trim operations yet again and with good reason … why would any sane person by a Hummer? I doubt that the typical buyer of an H2 has child seats in the back row and strollers folded behind them. That large demographic of young families would likely buy a minivan, smaller crossover or wagon. I can see the benefits of a pickup truck for many buyers but there’s a large group of models from the domestic automakers that simply have to go given that their target market is so small. High gas prices is just the final reason to adapt and the rationale for GM to make such maneuvers now while the Japanese and Korean automakers seemed to figure this out at least 5 years earlier gives good reason for top management in Detroit to be given the boot. Perhaps management wanted to take action long ago but government incentives and strong union action simply delayed the inevitable.

The real credit concern I have for Main Street however is when mortgage and auto related obligations lead to greater use of credit cards as a safety net. Maybe it’s just me but “credit card” and “safety net” are opposites. About as far apart “opposite” as Stephen Hawking and Homer Simpson despite their link to quantum mechanics. Yet, what are their options? Bank loans will be clearly harder to come by. Methods of the past such as home equity loans are no longer available. We’re quickly in a different world. The pressures to consume will have to be restrained but I’m no sociologist and I only wonder if the real fear of “losing it all” will curb spending patterns. I foresee trouble with auto loans affecting the domestic auto industry as similar problems with credit cards would affect Walmart, restaurants, leisure/gaming/travel and so many components of the economy. Banks will try to stimulate spending just like homebuilders are now pushing “buy one house get one free” deals. At the end of the day, I think it will be market forces that hit the consumer with the final blow of reality. Unfortunately, I feel like mortgages are just the beginning. It could be the first of many domino trails that fall in sequence and all we can do is watch. It’s the growing social fear that should help in increasing the average savings rate even a little which I think is all we need … nothing too drastic. Or maybe I’m just keeping expectations in check.

As an aside, I should add that the consumerism of North America is clearly growing globally to other markets. It’s not just Dubai but major centres all over the emerging world be it East Asia, the Mideast, Latin America or Russia/Central Eastern Europe. We’re hearing constant reminders these days of rising food, fuel and housing prices globally and this includes the developing world. Yet there is simultaneous high growth in the sale of luxury goods. Hand made Swiss watches, Italian cars/motorcycles, designer handbags, cigars … the necessities of life I suppose. Or you’d think that by visiting these regions. There are some neighborhoods in large North American cities dominated by high end automobiles. However, I’m always surprised at how this pales in comparison to what I can only say are the new centres of influence around the world. Dubai was a bit of an eye opener but now I’m interested in seeing what Moscow is like. Of course, the spread between the “haves” and “have nots” is very significant in the developing world but it’s surprising just how wide the disparity is. But all things eventually swing back the other way. The typical middle class US consumer will learn to adapt just like the typical Japanese worker figured out that the concept of lifetime employment with one organization is over.

So what other areas of the credit space will hit the everyday consumer not just in the US but for the growing “big spender” global citizen? Like auto loans and credit cards, each of these other potential chain of dominos are all part of a growing credit contagion that would have far reaching implications to the capital markets. To what degree and for how long, no one can say now and the economists will have to build new models to figure this out. I wonder if the parallels to the depression era will continue and be a basic assumption in these models.

Since this is “The Beta Brief”, I’d like to link the above commentary to the industry of beta oriented instruments. Both the ETF and derivative markets will have to be less US centric and gain further access to international markets and especially the developing world. Perhaps we’ll see the same result of redundant product offerings. With all the unnecessary, overlapping exposures in the ETF space that are especially focused on the US equity markets I can only assume that many of these funds will close down or merge. At this point, the recent closures at Ameristock of five Treasury bond ETFs in addition to those from Claymore a few months earlier are a telling sign of the excess of product growth that has been a defining story in the relatively short ETF saga. Well, it’s actually about 15 years. But if the writings of Fareed Zakaria and Mohamed El-Erian give insight into the future significance of the US economically and politically, the real attention of investors … and ETF providers … should be internationally. In the US, there are just about enough ETFs available to establish any sort of international diversification by region/country, sector, market cap or theme with very few holes remaining. However, we certainly don’t have that full availability of products in other jurisdictions. It may never get to be as crowded elsewhere as it is in the US now. It’s just a matter of time before the ETF industry expands in a more robust way to other parts of the world.

The current volatile environment with strong up days like yesterday (June 5th) but with even more down days does not seem like the best of times for passive instruments except perhaps for levered long and inverse exposures … basically, derivative markets and ProShares ETFs (I know, there are other providers now with levered long and inverse ETFs aside from ProShares and Rydex). The past year has been the time for hedge funds. Like the bear market of 2000-2002, we should see many hedge funds, but certainly not the majority of them, perform well but many investors in them come away somewhat unsatisfied. My guess is the final result in this downturn will be even less palatable for the vast majority of investors in hedge funds. Of course, those that do find success will have it big. It’s black swans and higher moments to the extreme. But I wonder if the strength in the ETF market which took place since 2003 was the result of investor dissatisfaction with the performance of active managers during the preceding market declines. And if so, will there be the same result at the conclusion of this rocky period?

The chart above would provide a more useful picture if the vertical axis was logarithmic. However, we can see that the current market declines of the past 11 months or so are still relatively small in comparison to what occurred earlier this decade. The same is true for the DJIA and the Nasdaq as well as international markets.

Who knows what the maximum drawdown will be from the highs of July and October ‘07? I’m starting to think that we might be in a longer term sideways market where the S&P bounces somewhere between 1,200 and 1,600 for a few years with continued high volatility … again, hedge fund heaven. If we have anything close to this scenario in our highly synchronized global market - well, actually anything other than a strong bull market like we saw from early ‘03 to mid ‘07 - then this should be a great time for active management as opposed to passive. In this scenario, passive management will be seen as something for old “has beens” and we’ll hear the same arguments against indexing as we heard in 2002. However, I think that the ETF industry has become, and will continue to be, less about buy-hold and a Vanguard-like philosophy but rather about the use of passive instruments within active strategies. Deb Fuhr (formerly of Morgan Stanley … anyone heard where she’s headed?) recently came out with a report noting that hedge funds are the 2nd biggest users of ETFs after financial advisors. Clearly, the active trading of ETFs, like it’s been in the derivative markets, will be hot and I see a growing list of managers of all types employing the use of ETFs in addition to single securities. I’m surprised how many managers I find today who use ETFs only within highly active mandates.

Funny enough, I hear these managers asking for more product related to foreign exposures and more niche offerings. It’s exactly where the industry has been headed in the past couple of years. We can see evidence of this with the continued success of ProShares and their move to foreign markets. Their levered long and short exposure funds are catered to the active investor. For those of you who are wanting some similar instruments that access certain commodity markets, ProShares manages ETFs for Horizons BetaPro here in Toronto providing long and short exposures to gold, oil, natural gas and agricultural grains. [Note: This isn’t a recommendation in any way. Just pointing it out to you.]

Like the Asian contagion of ten years ago, this is a time of serious crisis providing opportunity for the most active of active managers to shine. The long-term oriented investor will have to conduct a serious gut check to determine how their asset mix pie will deviate, if at all, should they consider the next five years or so to be anything but an up market similar to the past five years ending this past December. Another term making the rounds in the financial press recently is “depression”. Since I don’t see the US economy or the world as a whole going down to that degree (one of the reasons for my view of a sideways market over the next few years) the only form of depression I find applicable today is that related to mental health given the fear and then realization that the “American Dream” for many might be delayed and unfortunately for many more in the middle class, quite unattainable. This sad situation applies globally due to the spread of this credit and liquidity crisis beyond the US. However, the real key problem is the US. Fareed Zakaria’s article notes that the global shift we see today is less about the decline of the US and more about the rise of everyone else. His argument make sense given its lead in innovation, among other advantages, that come out of the robust economy that is the US juggernaut. But it will be the resiliency of the US consumer (along with their government and central bank to assist them) and their ability to adapt to this credit/liquidity crisis that will determine the course of things to come in the next few years.

For the most basic investor, the simple hedge might be increased allocations to international and especially emerging market exposures via decreased US exposures. That likely won’t be enough though and the importance of alternative investments, skill in picking successful active managers ahead of time and the ability to wrap this within an effective risk protocol might be what’s required. It’s a tough world.

I can’t believe it’s already a year since I was in Miami and soon thereafter writing my synopsis of the event, one of the first ETF conferences I attended in the US. At this year’s event, the 8th Annual U.S. World Series of Exchange Traded Funds East, being held this coming Wednesday and Thursday in Miami, I’m participating in two panel discussions and you’ll notice the common theme in both as found on the online itinerary:

ROUNDTABLE: THE SEISMIC SHIFT FROM BETA TO ALPHA
Previously, the onus to generate Alpha was squarely on the shoulders of the advisor as he utilized the Beta products the industry provided. Now the industry is prepared to shoulder the burden as evidenced by the amount of actively managed ETFs in development.
• What is the distinction between actively managed indexes and actively managed funds?
• How are absolute return and 130/30 strategies provided for within the ETF structure? • Will these products take the place of, or complement, core holdings?

ROUNDTABLE: DELIVERING ON THE PROMISE OF ALPHA VIA BETA EXPOSURE THROUGH SECTOR INVESTING
Many advisors rely on the ability to over/under-weight sectors in order to deliver Alpha for their clients. During this session, we will elaborate on the various characteristics that define the broad array of sector funds.
• How does one differentiate between economic sectors and industry classifications?
• What are the merits and constraints of established classification providers versus niche providers?
• What are examples of the strategies advisors can employ?

No surprise that investment industry events are having a lot of discussion related to both alpha and beta. Everybody wants to have the beta exposures during the long and steady bull market but with the volatility and downward pressure over the past nine months or so, the talk is all about minimizing the pain. Another session (following the 2nd one above) is titled “Preserving Capital While Pursuing Non-Correlated Returns With Fixed Income ETFs” so I suppose the common theme here is using beta (ETFs) to deliver some broader form of alpha (not at the “group of stocks in a particular asset class” level but at the broader asset mix level). The question one must ask is whether this type of outperformance, whether in down markets or generally speaking, delivered by tilting and/or actively rebalancing a portfolio based primarily or exclusively on ETFs can generally be described as alpha? I’d say a definite “yes”.

Well, I think it truly is alpha if you’re really doing something different and I’ve already outlined in my recent interview with IndexUniverse.com what I think about defining alpha and beta. Now that we’re in the middle of a serious down market, the kind of which we haven’t seen since 2000-2002, it’s interesting to see the timing related to what is now happening in the ETF industry. More rules based approaches and now even further in that direction … certainly the big topic of the ETF conferences … full blown active management. In my mind, the questions to ask are:

• what sort of actively managed ETFs will we see and will they provide value to investors, and
• will they, in aggregate, gather significant assets under management within the first few years

To me, if the vast majority of actively managed ETFs are nothing more than mutual fund-type mandates listed on an exchange, I’d be very disappointed. My guess in such a situation is that investors would not find much value there even with a significant reduction in management fees and furthermore when considering the various additional fees found in mutual funds but not in ETFs. But that’s not the real problem.

The ETF industry has its origins in classical indexing. Something more akin to benchmarking than what may be considered an investment strategy. It just so happens that market cap weighted indexing seems to do very well versus a broad array of active managers who, for whatever reason, are constrained by various measures such as a limitation on how much cash to hold, the inability to short securities, etc. For decades, the indexing and then the ETF industry have espoused the benefits of low cost, broad diversification, tax advantages and various other arguments for passive management. Now the ETF industry is simply going to add the active management chant? I’m not so sure if the chorus will be in harmony. But should it? I don’t think it has to … know one said the ETF industry is supposed to be only about indexing. Fundamental indexing and inverse ETFs are examples of pushing the boundaries within the ETF marketplace.

Perhaps what we’ll find are a relatively large number of small ETF providers focused on active management strategies along with a smaller number of large ETF providers (PowerShares would be the obvious example) competing with them. PowerShares and a few other existing ETF providers have never shared the same arguments of indexing and passive management as Vanguard, BGI and State Street have. With fundamental indexing and other rules based strategies as well as various thematic (water, cleantech) and unique sector exposures (nanotechnology), there seems to be a logical progression for PowerShares to move into pure active management.

To be fair, it should not come as a surprise for anyone familiar with BGI and State Street’s institutional business to see them come out with actively managed ETFs as well. For those who know, both BGI and SSGA run alpha-oriented programs (I don’t know if they call them hedge funds) and even run them along with the beta mandates - for example in portable alpha programs. Somehow, I see these behemoths taking a “wait and see” approach to recent regulatory developments. On the other hand, in an earlier post, I speculated on how the global reaching investment banks would be a logical provider of alpha oriented products in the form of ETFs.

Getting back to my main argument - let’s move beyond the ETF provider and to the ETF user. Let’s take financial advisers and investment counselors since they are a large and growing group among ETF users. For those in this group that have made ETFs a staple in their portfolio construction process, I believe they all have a common set of themes. It likely revolves around the limited role of manager selection, securities selection and market timing. They likely focus on fairly basic strategic asset allocation and an even greater focus on the use of the most vanilla of ETFs as core holdings. Depending on the type of client, they may also employ significant use of mutual funds from either Vanguard and Dimensional Fund Advisers, if not both. Do you think many of these advisers use actively managed funds? I’ll bet many if not virtually all of them do. A more important question to ask is what proportion of their client portfolios are weighted towards active funds versus passive funds. For the many pro-ETF users globally that I know, the use of actively managed funds is rather limited. Thus, I don’t see them getting excited about actively managed ETFs as a replacement or even an improvement over mutual funds. The same is true in my opinion for the do-it-yourself investor. Are the advantages of the ETF structure over the mutual fund so great that one would use the Fidelity Magellan ETF over its existing mutual fund counterpart?

I believe that the vast majority of investors who will get into actively managed ETFs will already be very familiar with existing (passively managed) ETFs. They’ve been bombarded for quite some time on the benefits of ETFs and the “evils” of active management. Let me be clear: I’m not against active management … I just don’t think that building an actively managed ETF with an underlying active strategy typically found in a mutual fund will do well. The typical ETF investor knows too well the difficulties for a US large cap equity fund manager to beat his or her relative benchmark. So what do I think might be a better approach?

Well, what we’ve seen in recent years is the ETF industry’s move towards alternative asset classes and themes. We’ve recently seen the introduction of an international inflation indexed bond ETF. Commodity related ETFs have come to market in such an intense wave the likes of which I haven’t seen since Nasdaq related products in 1999 and 2000 (market top signal?!). Part of this is chasing the hot market but part of it is also an attempt to cover new ground in terms of capital market exposures not yet “ETF’d”. Ideally, these new markets (frontier markets, carbon credit markets, etc.) may have great diversification properties although the ability to turn them into ETFs may be difficult logistically at this time. And so …

And so perhaps the successful actively managed ETFs will be those that continue this trend of providing some uncorrelated or risk-focused approach as an “add on” to what most ETF users already have. I suppose what I’m saying is that actively managed ETFs may be looked upon by the majority of existing ETF users as the “satellites” to a fairly basic “core-satellite” approach. And the core? Check the stats for AUM in the ETF industry and it’s the standard names (SPY, EFA, QQQQ, EEM) providing broad exposures. From the tables provided in this Street.com article, it seems that investor attraction to these traditional core products is solid. It even surpasses the 80-20 rule. From what I can see, nearly 80% of total ETF assets are in top 10% of ETFs. At the extreme, we find that 93.6% of total ETF assets are in the top 25% of ETFs. That means 6.4% of total ETF assets are in the bottom 75% of ETFs. This table from Street.com says that the aggregate net assets for ETFs are at $561.4 billion and that there are 649 ETFs.

Breaking out my calculator, I find that 6.4% of $561.4 billion is $35.9 billion. And 75% of 649 is 487 (rounded to the nearest whole number). That means that there is $35.9 billion in the bottom 487 ETFs. Thus, there’s $0.074 billion on average per ETF. Assets under management of $74 million on average per ETF in the bottom 3/4 (based on size). It would be interesting to see the dispersion of AUM over these 487 ETFs. What percentage of these funds have AUM under $20 million and can they survive for long at this level or less?

Clearly, it’s tougher to really hit a home run in the current ETF marketplace. The concentration of assets within a relatively small number of very large ETFs tells us something especially when you go down the list. Aside from gold (GLD), China (FXI) and Brazil (EWZ) in the list of the 25 largest US domiciled ETFs, everything else is fairly stock or bond index ETFs. Still, we see that a few new offerings from truly unique providers like ProShares seem to be making their mark and there will certainly be those in the actively managed space who will find similar success. But they’ll have to do something even more unique to get the interest of investors. I have a few ideas on what they might be. Broadly speaking, I think they’ll have a philosophy similar to the general hedge fund mantra: market neutral or very low correlation to markets. Or perhaps some sort of “Black Swan” effect to help during times of extreme market distress (not just a VIX ETF). The imagination of Wall Street never disappoints so we’ll just have to wait and see what they deliver. But again, providing a mutual fund in ETF form … well, we’ll just wait and see if that idea works but my guess is that in 3 years we’ll find that:

• the split between the ETFs of today (index and rules based) versus truly actively managed ETFs will be somewhere like 90% to 10% respectively at most. The wild card might be actively managed closed end funds that convert to an ETF structure but even then, I still believe the far heavier weighting will fall to the more traditional ETFs (non actively managed) of today.
• of the actively managed ETFs, I think the largest ones will be some sort of multi-asset class strategy as opposed to a single asset class strategy which fits in some form of fund classification (like Morningstar’s). This would include “ETFs of ETFs” which for some reason seems to be an idea that I think will catch on well and become a highly competitive arena.
• although I don’t believe hedge fund managers will use an ETF format to gather assets, I think that some similar strategies (hedge fund replication, 130/30) will find their way in. Further evidence of my alpha/beta convergence theory mentioned in recent posts.
• I wonder if the tax advantages existing today for ETNs will continue and if so, would underlying actively managed derivative-based strategies be employed. I believe that high frequency derivatives trading is generally treated as income and I wonder if wrapping it in an ETN provides a delay for the realization of a taxable event for investors.

Lawyers and accountants are likely having many conference calls with ETF providers these days over the recent news regarding actively managed ETFs. These participants will help drive the ETF industry in one of several ways. Some of these paths I foresee leading to similar difficulties now found in the mutual fund industry. Others do not but lead to other problems. It will certainly be interesting to see how things develop in this next stage in the industry’s evolution. One thing’s for sure: With the recent news of potential streamlining of ETF filings with the SEC as well as the introduction of actively managed ETFs, just think of floodgates opening. Any commentator complaining of too many ETFs better start resting well and taking your supplements … you’re likely going to be shouting the same from rooftops by the end of this year.

Well my continued lack … well, maybe a better word is reduction … in blogging has been compensated by increased conference speaking. Aside from the event in Singapore I participated in last week, the other recent big ETF event was the “Inside ETFs” conference in Palm Beach Gardens Florida in January. The organizers of that event are a multi-armed entity called Index Publications LLC who publish the ETFR (Exchange Traded Fund Report) and the Journal of Indexes. IndexUniverse.com is their online portal and, in my opinion, along with the published work of Deborah Fuhr at Morgan Stanley provide pretty much all there is to know about indexing and ETFs on this planet.

I know that I’m keeping up with these experts after having bumped into Jim Wiandt (President of Index Publications and Publisher of IndexUniverse.com) in an event last year in Hong Kong. I’ve seen Deb Fuhr at basically every ETF related conference I’ve been to in the past year including the one in Singapore and we’re both speaking at an emerging markets derivative/indexing conference next week in London that should be very interesting as there’s great debate these days of the merit of investing in the developing world given the global market turmoil.

But this post is to let you know that IndexUniverse.com has put up an interview I did with them recently. I’ll likely get a bump in traffic to this blog (heartfelt thanks to IU) and I only wish I had more recently published material up for new visitors. Truth is that I have about a half dozen drafts sitting on the back of this site ready for finishing touches … some of them written many months ago with data/charts that need updating. I suppose I should be writing about the latest regulatory news about actively managed ETFs or maybe something on ProShares’ upcoming 130/30 ETF. There’s actually a lot of interesting new stuff out there in terms of product and industry developments but what interests me even more is the broader picture and what’s happening in this major down market. So here it goes …

I believe that this is where all the more interesting ETFs will “make it or break it”. What has been the trend in ETF land over the past couple of years? Not plain vanilla, low cost ETFs but the exact opposite: Niche sectors. Emerging markets. Thematic funds. Inverse exposures. Many of these have very low correlations to the bread and butter SPY/QQQQ type of holdings. The inverse ETFs go further in providing the zig while the markets zag. Yet, of course, we find what happened with Claymore and their fund closures. Clearly, there will be winners and losers. But these are exciting times for the industry. Many of the new products should do well in this tough environment but many won’t. There’s a parallel to hedge funds (I always do this!).

Nearly every hedge fund manager must have been sweatin’ it during the long and continuous bull market of 2003 to 2007. Basically every hedge fund manager should be in nirvana in this current market environment. The truth is that many are taking advantage of what the market is now providing them but I’d bet that many, many more are in their own version of hell. It’s tougher and tougher to find alpha out there and doing well in down markets is not the same sport for hedge funds as it was thirty, twenty or even ten years ago. Just darn too competitive. Finding a really good hedge fund that isn’t closed to new investors is tough. Thus, building a robust portfolio of hedge funds must be close to impossible. Certainly, the evidence from hedge fund indexing seems to show that the more you try to diversify hedge fund holdings, the more it becomes simply ultra-high cost closet indexing.

I believe that successful hedge fund investing is possible if you have the adequate resources. The term adequate usually evokes a feeling of minimal requirements … this does not apply to hedge fund investing. I’m not talking about minimum investment amounts but the acumen required to provide the necessary qualitative due diligence as well as forensic accounting needed to properly filter the good from the bad. Unfortunately, not everyone can be Yale. And for too many investors, the premium for giving up liquidity and transparency is simply not enough. ETFs, way over at the other end of the active-passive spectrum provide both liquidity and transparency … and now access to the small corners of the global capital markets complex.

Could this be why ETFs and their move towards niche offerings and now active management have the potential do grow even within a lengthy down market? That has always been the argument against indexing and ETFs … they fail to do their thing in bear markets. But if ETFs are no longer just about tracking plain ol’ S&P 500 and MSCI EAFE but providing inverse equity index exposures and currency hedges and low correlated commodity exposures and so on - well then it’s certainly possible to be bullish on ETFs in a bear market.

Lehman Brothers have now entered the ETF fray (actually, their product line up contains exchange traded notes) and they’re branded as Opta ETNs. Well this is an interesting development and one that I don’t find very surprising.

Let’s think about the ETF industry for a minute (I am aggregating ETNs and any other derivative of this type of instrument … no not that derivative … into the term “ETF”). Are we moving more and more towards alternative asset classes? Are we adding sexier functionality to products? Are actively managed ETFs on the horizon? The answer to these questions is not just “yes” but we’re basically there. If the ETF industry is less about beta and more towards something else … some alternative or exotic or “non-standard” beta and even possibly (wow!) alpha then watch out. Investment banks are going to jump in and then some.

Why wouldn’t they? Once you move away from the more traditional views of passive management, you’re moving closer to the I-banks sweet spot. The higher fees (margins) don’t hurt either.

One of the Opta ETNs covers commodities in general with a fantastic ticker symbol (”RAW”). Another covers the hot topic of the day, agriculture. And the last one brings some competition to PSP in the private equity space. Note how Lehman uses the word “Beta” in the commodity ETNs but not the private equity ETN. I agree … private equity is no asset class.

Regardless of classification, Lehman is entering the ETF/ETN space focused on alternative investments. It would not surprise me one bit if other I-banks enter in a similar fashion. Many, like Merrill Lynch have publicly spoken on their hedge fund replication products … they could be turned to ETFs. There are many ETFs that are in the middle of regulatory approval manufactured by existing ETF providers both large and small (firms that is) that, when launched in the market, would have no competition. These would be rather esoteric asset classes or strategies such as carbon credits or 130/30. Again, I-banks live and breath these markets and strategies and unlike startup ETF providers have the cash (some, thanks to their new friends, the Sovereign Wealth Funds) to make a real go at it.

If the I-banks do jump in to the ETF marketplace in a big way, there could be significant fallout. More products and more competition would make it harder for the many new entrants in the field (that are not I-banks or backed by them) to not only establish themselves but grow in a significant manner. Like mutual funds, hedge funds and other financial products, ETFs are sold not bought … just find out who makes the big money at these firms. I don’t see how the little guys could go up against a marketing machine heavyweight like a Lehman, Goldman, Merrill or Bear.

Worse still, I wouldn’t want to be a mutual fund right about now. Not only do they have to keep up with their lobby against the favorable tax treatment of ETNs but they must also be thinking about how to stop this whole active management ETF train from leaving the station. Too late … I think that was the whistle and last call.

Well, if you welcome competition (and you should), hopefully the average ETF management fee will at least go down … wait, we’re talking Wall Street I-bank heavyweights right? Check that. Don’t hold your breath.

A little over a year ago is when I really started getting out to industry conferences as a speaker. I had done a few here-and-there in 2005 and 2006 but nothing like now. I suppose that as a blogger, albeit a part-time blogger at best, conferences have become a logical next step on this particular tangent in my career focusing more on investing management from a “media outlet” point of view rather than a practitioner’s. Truthfully, I never saw any distinction between the two and I’ve always hoped what differentiated me from others is my past and present work as a professional market participant. Same can be said for guys like Roger Nusbaum, Tom Lydon and Barry Ritholtz to name a few … I’d consider myself very lucky to be compared with any of these guys.

More importantly, I strongly believe that writing down the thoughts in my head about a particular new ETF, derivative contract or interesting industry development is, in my opinion, a fairly novel way to “keep the knife sharp”. Portfolio construction is tough enough as it is but with new products and services continually popping up, filtering the good from the not-so-good is a worthy exercise. Interestingly, I found that the ETF assembly line slowed down enough last summer for me to go on hiatus (thus, the nearly zero posts in the past eight months). There have been quite a few new arrivals, some actually a bit interesting but somehow, not enough to get me excited and write about them. Or maybe I’ve just been lazy. Perhaps some laziness but also a bit of consulting work thanks to the blog and even more due to the conference speaking.

Thus, the conference speaking has not only been an additional forum for me to assert opinions/ideas and discuss/debate them but also to see where that sort of dialogue takes me. And along with this blog, these conferences have taken me in many interesting directions. Funny, but that could be taken in many ways. For example, here’s my speaking calendar as of now for 2008:

Inside ETFs Conference, Florida
o January 10-11, 2008
o http://www.insideetfsconference.com/index.php?Itemid=295&option=com_content

Indexing & ETF Investments Asia 2008, Singapore
o February 27-29, 2008
o http://www.terrapinn.com/2008/iia/

DICE Emerging Markets 2008, London
o March 11-13, 2008
o http://www.terrapinn.com/2008/DICE/index.stm

8th Annual US World Series of ETFs “East” Conference, Florida
o March 26-27, 2008
o http://secure.imn.org/~conference/im/index2.cfm?sys_code=20080331_IM_0036&header=on

Base Metals Investment Summit 2008, New York
o April 1-2, 2008
o http://www.iqpcevents.com/ShowEvent.aspx?id=49544&details=69950

Financial Advisor Symposium, Las Vegas
o April 16-18, 2008
o http://www.financialadvisorsymposium.com/lasvegas/main.asp

Commodities Investment World MENA 2008, Dubai
o May 26-27, 2008
o http://www.terrapinn.com/2008/ciwae/

ETF & Indexing Investments Europe 2008, London
o June 24-27, 2008
o http://www.terrapinn.com/2008/etf/

Quite a bit in terms of market coverage as well location (so as I said above, “… in many interesting directions.”)

The last event listed above is still tentative (in terms of my involvement, that is) as are a few more I am in discussions with at this time. This list was a lot shorter only one month ago. I’ll bet that in another month or two, I’ll be set for the year. My aim is to limit myself to no more than two events per month with likely a quiet July/August. Clearly, most of the events are focused on ETFs/indexing but, perhaps not surprisingly there are other conferences covering specific areas of the capital markets or investor types that have sections dedicated to beta and in most cases that means ETFs.

I’m not entirely certain, but my guess is that only three years ago there may have only been, at most, a half dozen conferences entirely dedicated to ETFs/indexing with all but perhaps one in the US. Today, not only would I say that there are, on average, at least two ETF/indexing events per month globally but from the above you can see that the interest in passive instruments and beta has expanded beyond the US albeit ever so slowly and in a very limited manner. Internationally, the interest has always been there of course, but now we’re seeing greater product development and overall acceptance of ETFs beyond the rather saturated US marketplace.

Still, as explicitly stated at an ETF/indexing conference I recently attended in Hong Kong, ETFs have a long way to go globally. Aside from the fact that that was the first mainstream ETF/indexing conference I had ever come across in the region (there have likely been a few in the recent past) another strong indicator for me was the fact that the event had a rather small group in attendance. From the discussions I had with many at the event, it was not surprising. In general, the consensus is that East Asia still wants to search for alpha (via hedge funds) rather than focus on low cost beta exposures (via ETFs). Who can blame them with all the market volatility especially in the region? But the stats don’t lie and one can see that the ETF growth internationally both in the number of funds and in “assets under management” is similar to the US perhaps as far back as ten years ago. A slow and steady climb will continue for a few more years and regardless of bull or bear markets, there will be an explosion in the ETF marketplace as investors realize that the beta/alpha combination (ETFs plus hedge funds/private equity/other alpha generators) makes sense for them. We have already seen major indexing and ETF providers build operations internationally including the Pacific rim … the speaker list for the upcoming event in Singapore confirms this.

Speaking of Singapore (the first event listed above), it’s the next ETF/indexing conference in the East Asian region and my first time as an event chairman. We’ll see if the turnout is better than what I saw in Hong Kong only three months ago. While I’m sure the size and scope will be nothing like, say, the Superbowl of Indexing I will be interested to see if there’s some growth at least in the turnout. The attendance at a conference might seem trivial but I’ve been at quite a few over the past decade or so and the one thing I’m certain of is that the number of people attending conferences is proportional to the market interest in its area of focus which usually is at its peak near the same time as that of the market.

Aside for one event (Las Vegas) the conferences shown in my list above are generally for professionals although I don’t suppose there’s anything stopping a keen private investor of any sort to attend. Gauging the market situation with industry conferences is one thing but it may be even better to consider conferences geared towards the private, self-directed investor as they’re often the last to join the party.

Now how about all those conferences to “teach” you how to go about buying and flipping real estate … you know the ones on TV shown late at night along with food processors and exercise equipment? Where’d they all go? Almost too easy as a long-term market signal. But as with many sell signals, I’ll bet those commercials came off the air too late.

Roughly a year ago, I wrote a post discussing the concept of alpha (that rare and valuable thing) which becomes less rare and eventually commoditized into beta in time. Here’s a bit of what I said at that time:

Isn’t alpha supposed to be the returns from a strategy that is based on market inefficiencies? If so, then shouldn’t these market inefficiencies disappear as other players enter the field? This line of thinking is discussed in this paper available on SSRN:

By the way, this paper was written by market participants. At the time of its publishing, the authors worked for ABP Investments which, according to its website, is the 2nd largest pension fund in the world. This paper discusses how investment processes can be divided into two groups:

Traditional beta which they call “commoditized beta”. This is based on exposures to various markets and is the classic definition of market risk.

Traditional alpha which they call “non-commoditized beta”. This is based on other risk factors not associated with market exposure.

Basically, the writers of this paper sum up things well in four points (bottom of page 4) provided here ad verbatim:

1. Any investment process which today generates return by taking exposures, which are not well known, will become obsolete progressively, as the exposure premium reduces or the exposure is commoditized.

2. As exposures become commoditized, the space to generate additional alpha return (from the residual) decreases, and the space for beta return increases.

3. There is practically no alpha based exposure, which cannot be commoditized.

4. The investment problem which originated in finding exposures to generate alpha will gravitate towards becoming the process of analyzing when to take a specific commoditized beta exposure.

They go on to say that the alpha versus beta debate is irrelevant. “The eventual investment problem is therefore not to now generate exposure combinations, which would generate alpha, but to be able to time the betas of the existing exposures. We therefore believe that active management will devolve to an exposure based allocation process, where the objective is largely to allocate to different forms of beta, and where alpha does not actually exist. Portfolio diversification is then just the diversification obtained by applying the forecasting process to more than one beta.” This is basically a rewording of point #4 above.

A key point from the above I believe is this: ” … where the objective is largely to allocate to different forms of beta.”

Remember, this was written by some portfolio managers who were at ABP, one of the world’s largest pension plans. They’re trained and compensated to care about the long term horizon, not the short term. But it seems like what they’re saying is that not only should one NOT stick to only investing in the plain vanilla betas (broad market index exposures … let’s just call that the very large, broad, market-cap weighted ETF behemoths which generally come with low management fees) but in fact must allow for the niche exposures personified by the newer and more controversial ETFs that have higher fees. I’m assuming that these niche ETFs provide the required “different forms of beta” mentioned above. The writers say that alpha does not actually exist in these areas (this could be sector or regional exposures). They even go so far as to say that the investment problem should focus on the timing of the beta exposures.

Let me be clear: The moment you talk about timing beta exposures, you’re talking about actively managing your ETF holdings. I’m not sure if this is what the original ETF pioneers were thinking about roughly 15 years ago but I don’t believe that this paper I was referring to was written by two dummies. I have great respect for this philosophical exercise in thinking about alpha and beta.

Why do I bring this up today? Well today, I spoke at the Hedge Funds World Canada conference here in Toronto. I led a session in the afternoon focusing on matters related to beta within an alpha centric world (it’s a hedge fund conference in case the event’s title wasn’t clear). The session following mine focused on alpha but since the two greek letters are very much related in portfolio theory, there was some overlap.

Aside: Interestingly enough, I found the term “beta” used just as much (if not more) than “alpha” in this first day of this conference. There was a session on 130/30 programs. These mandates are engineered to remain extremely constrained so as to continually have beta of 1.0. Again, at a hedge fund conference. Beta 1.0!!! Isn’t that an index fund?! Well not necessarily but it kind of blurs the line between hedge funds and mutual funds. At the least, it certainly makes me think what Jones, Soros, Robertson and other “old school” hedgies would think about a mandate with a target beta of 1.0 being discussed at a hedge fund conference. 130/30 programs also called a variety of other names including “Active extension strategies” and are commonly discussed in many other events both related to hedge funds, ETFs and well just about any investment related conference these days. Think of it, currently anyway, as the rock star of the institutional investment community. Well, I don’t know about rock star … why am I picturing a bunch of pension actuaries dressed up in leather like Kiss for their office Halloween party? Note to self: Too much coffee at the conference today.

Well, from one of the discussions today, I was reminded of the concept of alpha as simply un-commoditized beta. And when I got back home, I found an email from HSBC about a new set of indices:

HSBC has announced the launch of its Global Climate Change Benchmark Index, together with a family of four investable global climate change index products.

The HSBC Global Climate Change Benchmark Index, developed by CIBM’s Global Research team, is a global reference index which has been designed to reflect and track the stock market performance of key companies that are best placed to profit from the challenges presented by climate change. The performance of the benchmark has been tracked back to 2004 and has outperformed the MSCI World Index by around 70%.

From this benchmark, HSBC has established four investable climate change indices that can be used to create portfolios for a diverse range of investment needs such as long only funds, hedge funds, exchange traded funds, discretionary funds and structured products. The indices are:

• HSBC Climate Change Index

• HSBC Low Carbon Energy Production Index (including: solar, wind, biofuels, geothermal)

• HSBC Energy Efficiency & Energy Management Index (including: Fuel Efficiency Autos, Energy Efficient Solutions, fuelcells)

• HSBC Water, Waste & Pollution Control Index (including: water recycling, waste technologies, environmental pollution control)

In creating these indices, HSBC has responded to changing investor sentiment in global equity markets. The HSBC research team has looked at a wide range of stocks and identified approximately 300 companies that are well positioned to benefit from the challenges of climate change.

Group Chairman Stephen Green said: “HSBC has long recognized the importance of climate change and has shown real commitment to addressing the risks and opportunities it brings. In developing tailored climate change indices we are providing real investment solutions which enable our clients to incorporate climate change into their investment decisions.”

By the way, attached to the email was a 24-page report from HSBC’s Global Equity Quantitative Research group and the lead analyst’s name is Joaquim De Lima. Please don’t ask me for this report as I don’t even know how I suddenly got on their mailing list. I provide this bit of info so that you can go to HSBC and make your own inquiry. Now my thoughts.

What can I say … another set of new indices. Am I surprised that again we see something introduced to the market within the realm of climate change? Not really. The entry of alternative energy related ETFs has shown no signs of slowing down and I have discussed this area several times in the past. By the way, have you seen how PBW has been doing?

Up nearly 40% year-to-date and despite some ugliness in concert with the markets this summer, a strong rebound in recent weeks.

Getting back to main topic, what I find interesting is that this sector, or perhaps parts of this sector, should be (only my opinion, of course) the domain of hedge funds. Although not a significant part of the above release from HSBC, ask yourself if the related space of carbon emission credits is really an efficient market. Take any of the above HSBC indices and ask yourself if there is an army of CFA/MBA/PhDs as well as Average Joes at home looking into these markets in the same way as Citigroup or Microsoft. No way … it’s just too new.

[FYI and another aside: I know that carbon trading is a hot topic and I’ve just mentioned it in passing here. According to the HSBC report, the sector breakdown of the overall Global Climate Change Index shows only three stocks (0.29% weighting in the index) to financials of which two (0.22% weight of index) positions are further classified as carbon trading. So basically, don’t think of this index or sub-indices as a strong play for the emissions trading market.]

Despite the fact that these new markets are relatively new, underdeveloped and lacking in the kind of information flow similar to most global large cap equities, I find it interesting that the commoditizing of what should be alpha-centric markets is happening with greater speed. This does not take away, of course, from the fact that within these markets there will certainly be traders, some of whom will be winners and likely many more who will be losers. Some will be alpha providers (losers) and some will be alpha takers (winners).

Thus, with new markets (relatively speaking when I use the term “new”), there will be opportunities for those with a beta point of view (assuming something like an ETF is quickly produced to commoditize that market) as well as those who are alpha-focused. This is not unique and goes simply back to the active versus passive debate which one must consider when investing in any asset class. My comment here, and what I find unique, is simply the observation that the commoditizing of alpha can be faster than one might imagine simply due to the evolution of the ETF industry away from broad market exposures and towards niche markets.

But coming back to the guys formerly at ABP: According to them, the beta point of view is actually a rather active set of decisions (timing beta) and thus leads to much less differentiation from the pure active point of view which is the hedge fund.

Confused? Then the newer niche ETFs likely have little meaning for you and a disciplined buy-hold strategy with a longer focus on the “hold” applies. Not so confused? Then maybe I’ll see you next week in Scottsdale Arizona for the “World Series of Exchange Traded Funds -West” conference where I hope to explore this topic and others in greater detail. Furthermore, for those in the Far East, keep your eyes on this blog as I’m hoping to get a spot in an indexing conference in Hong Kong as well as a fund conference in Seoul both in late November.

Hey, just thought of something. I just said that the speed of bringing an area of the capital markets to beta (that is, commoditized to beta in what would seem to be a healthy space for alpha oriented investors) has significantly increased. If that’s true then why is it that we’re only seeing the first international fixed income ETF coming to market now? Well, the shape of yield curves globally didn’t help as well as a nearly five year bull market whose growth rate looks steeper than what we saw in the 90’s (not including Nasdaq in the years before the top). So the commoditizing of alpha into beta is a concept which can not be gauged solely by monitoring the ETF marketplace. But it certainly does give a strong argument for the value and purpose of the many new entrants (and soon to be entrants) within the ETF community.

Thoughtful and significant exposures that have a real purpose within a portfolio construction process. If this is what new entrants in the ETF industry provide with their new product offerings, then I think it’s a good thing. As usual, the market will decide this.

Well, not here if you’re anywhere outside of Canada. And not here, meaning not “right now”. But close (if you’re an American) and soon in terms of wait time.

As a follow up to my recent posting, “Funds Of ETFs Are On Their Way“, we now have news from Claymore Investments in Canada of the world’s first ETFs of ETFs. If someone knows of others already available, please let me know.

Here’s what I know and it’s straight from the source:

Tomorrow, Claymore Investments is launching the Claymore Global Balanced Income ETF (TSX:CBD) and the Claymore Global Balanced Growth ETF (TSX:CBN). They are the first ETF Wrap portfolios in Canada (and the world) to provide a single ETF as a core part of an investor’s portfolio.

As a wrap, these global wrap ETFs are made up of about 13 ETFs and focus on balanced portfolios bringing investors the ability to buy one product and access multiple asset classes giving exposure to fixed income, equity, real estate, commodities and other sectors.

TSX:CBD and TSX:CBN are based on a Global Balanced Index by Sabrient Systems, a partner of Claymore Investments out of California, who focus on dynamic asset allocation models using equity and fixed income.

Claymore strives to provide a lower cost option, and these ETFs follow that tradition by using lower cost structures. Management expense ratio of these ETFs is 0.7%, which includes the fees of the underlying Claymore ETFs in the portfolios. Claymore is excited to offer Canadian investors these innovative single portfolio solutions. A formal press release will be issued tomorrow – and more detailed Investor Guides (PDF documents) will be available.

So, we now have ETFs of ETFs. Not a big surprise when you think about it. Packaging a portfolio of stocks into mutual funds, mutual funds into a wrap program and hedge funds into a “fund of funds” makes sense for a lot of reasons. The application of this to ETFs would only be a logical step. Certainly, this development will expand as more competition enters the marketplace. I’m eager to see if BGI, SSGA and Vanguard decide to enter into this field. If they do, it might be a half-hearted approach with each provider building wraps with their own in-house ETFs only as ingredients. From what I understand, the Claymore offerings will not only have Claymore ETFs but those from other providers as well. We’ll know more tomorrow.

I also understand that other similar products are in the works in the US. These would be new participants in the industry … names most of you likely have not heard of yet.

I wish to reiterate my comments from the earlier posting on this subject. The fees will matter. What I hope to see is that these wrap programs develop into two groups. The first providing very low cost exposure to a well diversified group of ETFs. The second providing more of a highly active management program (GTAA?) that would justify a significantly higher fee. What “very low” and “significantly high” are, only the market will determine. But an ETF of ETFs that is well diversified, not overly traded and espouses the benefits of low cost investing, better not have a high overall MER or this exercise simply becomes counter-productive.

The concept of a “wrap program” has been around for years and the idea is quite simple. The novice investor hands over one of the more fundamental components of the portfolio construction process, namely the asset mix decision, to a professional. Of course, this service should also include the ongoing rebalancing required for the portfolio. If asset allocation is the main driver of portfolio returns (actually, the 1986 Brinson/Hood/Beebower study says it’s the key determinant of the variability of portfolio returns), then it makes sense that novice investors should get advice from professionals for this key function as much as they do for securities selection.

Of course,this service comes at a cost so one of the primary downsides for such programs is the added layer of fees. For a portfolio of mutual funds, however, the risk is that the overall portfolio provides little beyond market returns at a high price. Despite this, the concept exists not only with mutual fund wrap programs but beyond. Another example is the “fund of hedge funds” (more commonly known as simply a “fund of funds”). In this case, the fund of funds manager must consider the mix of hedge fund strategies which is altogether a different sport from the mutual fund wrap program. In either case, the overseeing manager is a “manager of managers” and will likely assert in their marketing material that they have skills in selecting managers. Of course, just like no one wins in a sport all the time, managers can’t be top decile for long which is why I’ve labeled the manager selection process earlier as “sport”. Ali, Pele, Jordan, Schumacher, Tiger Woods, Federer … there are countless examples of sporting figures who did or are doing more than simply excel beyond the competition. Dominate would be a better term. But just like Peter Lynch, Bill Miller or Warren Buffett, winning streaks don’t last forever. Dynasties like those from the Chicago Bulls or the New York Islanders are rare but I think are rarer still in the fund management space. Thus, the idea of picking winning managers is truly a tough sport.

So, how about an “ETF of ETFs”? It’s still tough but at least you’re taking the active management component away from the process … or are we? The way the ETF industry is moving, active management will soon be as common to ETFs as it is in the rest of the fund universe. Whoa, I suppose there’s a case for a wrap program of ETFs or some “fund of ETFs” or “ETF of ETFs”? Well, based on what I’ve just said about selecting managers, maybe not a case for the investor but maybe one for the product provider. Oh, they’re coming.

Here’s news of a fund company that will build a series of mutual funds holding only ETFs to track the Lipper ETF Indexes which David Hoffman of InvestmentNews has recently covered. As a quick review, Lipper has essentially created a family of “target risk benchmarks” made up entirely of ETFs (which I don’t think have been made public and I wonder if they will be?!). The five indexes are:

• Lipper Optimal Aggressive Growth Index
• Lipper Optimal Growth Index
• Lipper Optimal Moderate Index
• Lipper Optimal Conservative Index and
• Lipper Optimal Very Conservative Index.

Sounds like a typical family of wrap programs … the one that you get slotted into after filling out a form with a couple dozen standard questions. I’m not sure if other such target benchmarks exist, but this could be a place to start for investors who have built a portfolio consisting primarily, or exclusively, of ETFs. I’ve said this before but I think it’s worth repeating … why someone would limit themselves to just using ETFs is beyond me. ETFs are great and have many worthy benefits but to put such constraints on oneself is rather pointless. ETFs are ideal but not for every investor in every situation … there are areas of the capital markets where an ETF is simply not the best choice for you. As much as I may like any financial instrument, I wouldn’t want to be handcuffed to them exclusively.

Still, for those who have built a portfolio with extensive use of ETFs, these Lipper benchmarks provide a gauge for comparison. A good or bad gauge, I just don’t know because, again, I don’t know what are the ingredients nor the recipe.

I started this post talking about the asset mix decision. But is this the case for a fund of ETFs? In a way, it’s still about the asset mix but talk to any advisor who uses ETFs in their client portfolios, or in fact any ETF focused investor, and they’ll likely tell you that the selection process is as important. With all the ETFs out there, is that a surprise?  And with the exponential growth in terms of the number of new offerings, perhaps asset allocation will take a back seat to securities selection.  Right away it makes me wonder if that’s a good thing. Although it’s not manager specific selection (or at least, until more actively managed ETFs are introduced to act as components within a “fund of ETFs”), it’s still moving towards the sport of chasing returns. So, one area of inquiry into these new wrap products (that’s essentially what they are, right?), as well as existing services at financial advisory firms that focus on managing ETF based portfolios, is the extent to which active management is applied to these programs. Questions could include:

• What is the overall portfolio’s turnover?
• Is rebalancing based on fixed periods (semi-annually, annually, etc.), based on volatility (for example, if a position moves X% from its initial allocation then it moves back to X%) or some other rule?
• What is the average holding time for core and non-core positions?
• What are the total number of holdings at any given time and is there a minimum or maximum number of holdings?
• What is the universe in which the manager can select funds from?
• How does the manager deal with new ETFs that get introduced into the market and what determines if it becomes part of the opportunity set?
• What would make one holding be deemed more appropriate than another holding?  For example, would VWO ever be considered a full replacement for existing EEM positions.

Active management will always be a part of the investment industry and that’s no surprise for many obvious reasons. Furthermore, the use of ETFs in organized portfolio is not new. Many financial advisors in North America have built a practice around the use of indexed instruments (index funds, ETFs, etc.) but no matter how much they believe in efficient markets, there’s some degree of active management in what they do. There are many planners who focus their practice on the exclusive use of a certain family or families of funds usually with names such as Vanguard and Dimensional Fund Advisors. Like ETFs in general I don’t like absolutes and exclusivity, but these two firms in particular are cult-like in their focus on disciplined asset class investing with a minimal use of active management. It is the advisor who listens to such advice who I believe is doing the greatest service to their clients.

These are services but what about products? The next logical step is for fund companies to get into the action with funds of funds. In addition to the news mentioned above, through my contacts and with some poking around I know that there are more similar products on the way. It’s only a matter of time before we see ETFs of ETFs. Again, it’s about the movement towards greater active management in the ETF space. The real question is what degree of active management will be applied to such products and will investors in these products receive the benefits that ETF promoters have long suggested make them an asset rather than a liability versus more traditional actively managed products such as mutual funds.

What would be the worst thing for the ETF focused investor who gets into a managed program such as an “ETF of ETFs”? Some may think that it would be the decision to go with a manager who trades opportunistically and, like some well publicized hedge funds, shoots its lights out. There are mandates like this and the managers are not afraid to call them hedge funds nor are they shy about their performance fees. I’m talking about a totally different animal … the more traditional mandate.  To me, the real risk is that the overall portfolio provides little beyond market returns at a high price. In that case, the whole point of using ETFs has been lost.

Although based in Toronto, I focus so much of this blog’s content on the US marketplace simply due to the massive amount of industry development in the area of ETFs and derivatives. Of course, there is also news in this space that comes out of Canada, Europe and other regions of the world, but for some reason, I don’t seem to get the same amount of information flow.

In recent months I have spoken at ETF related conferences in the US but since beta (and alpha) are global beasts, I’m trying to gain some added exposure outside of the US. So, in a bit of self promotion, I’d like to comment here on two events I’ll be speaking at here in Toronto.

The first is the Canada Cup of Investment Management scheduled fo June 12-13. Here’s the link to the event’s website. But before I comment on the conference, I thought it might be interesting to give some insight to the history (albeit short) of this conference as I attended the first one in 2002. That conference was called “The Canada Cup of Indexing and Related Products”. If you follow this link, you’ll see that five years ago the world, or at least Canada, had a sophisticated view of the beta world. Of course, if you read the names of the speakers, you’ll note that this was a primarily institutional event although there were many sessions for the retail adviser/investor audience. For retail advisers/investors interested in the ETF/indexing space, I highly recommend that they try to attend these types of “institutionally oriented” events to keep up with what is happening at the leading edge.

In time this event has morphed into the Canada Cup of Investment Management. When this name change occurred in 2004, the byline was “where active and passive management meet”. So it wasn’t a complete departure from beta and this agenda from the 2004 event still shows the focus on indexing and ETFs and related products. In other words, I’d say that it was at around that time in 2004 when indexing became rather mainstream. It makes sense. It was at about that time when BGI and SSGA began to see the beginning of a new wave of competition in the ETF industry. It’s only been in the past year and a half when things have begun to grow rather exponentially.

Coming back to 2007, we have the following agenda for the coming event. I provide the links to the agendas for these events to give you the following insight:

• the list of sessions gives you an idea of what are the hot topics of that time.
• you get a general direction of the trend in the industry and the perception of beta and alpha as drivers of portfolio performance.
• people - who are the experts of what
• new asset classes and strategic thinking

You’ll note that I moderate a discussion on, what else, ETFs (Tuesday, June 12, Track B, 1:45pm) and speak again later that afternoon (3:00pm) on how financial advisers can think about building model portfolios based on what institutions are doing. Both are pretty broad topics and I’m excited about the speakers who I will be working with.

The second event I am involved with is the Hedge Funds World Canada conference (October 9-11, 2007). This event is quite a few months away so the agenda is incomplete in terms of the speaker listings however it does give an idea on the broad topics to be covered. Many may believe that the hedge fund industry in Canada is limited to stock pickers going long and short while focusing on a small group of industry sectors such as oil & gas, gold and uranium. Although there are many who specialize in the commodities complex, this conference agenda shows that the talent pool in Canada is quite broad although perhaps likely not as robust as in the US and Europe … it’s just a matter of time I believe.

I think it’s interesting that the Canada Cup of Investment Management is an event that has a significant level of content related to beta (indexing, derivatives, ETFs, etc.) based on its history, whereas Hedge Funds World Canada focuses more on issues related to alpha as opposed to beta, and rightly so. Everyone has been talking about the separation of beta and alpha over the past several years but it has been common to see philosophies and methodologies pop up recombining the two. Portable alpha is the most common term thrown around.

Perhaps it may be in the group of sessions on the first afternoon of the Hedge Funds World Canada event where this type of discussion will bring some new thinking in this area. The last three sessions of day one of this event fall under the broad heading “Alpha Beta Portfolio Construction”. Note that I’ll be leading the discussion for the first panel discussion on how beta relates to alpha. Here is what’s shown on the latest version of the online agenda for the afternoon section:

ALPHA BETA PORTFOLIO CONSTRUCTION

Panel session: How does beta relate to alpha?

· Beta sources – identifying the sources and choosing benchmarks

· The availability of exotic beta

· Getting comfortable with derivatives – financing costs, leverage and liability

· Rebalancing

· Liquidity

Panel session: Identifying alpha

· How to identify alpha in a hedge fund

· What is true alpha vs alternative beta?

· Hedge fund replication

· The combination of alpha & beta; implementing a 130/30 strategy

New opportunities from new strategies: Hedge fund replication and alternative beta

· Alpha and beta: an ever more blurry line

· What aspects of hedge fund should actually be replicated?

· A review of four different replication approaches

· The prospects of hedge fund clones

Not one mention of portable alpha. That would not have been the case over the past few years. Instead, 130/30 funds and hedge fund beta (commonly termed as alternative beta) are front and center. I have commented on the growing field of hedge fund replication strategies in the past with these postings:

· The Latest In ETFs Makes Me Think: “Are We There Yet?”

· Index Providers: Commoditizing Alpha To Portable Beta

· Merrill Lynch Releases New Hedge Fund Replication Index

· Hedge Fund Replication Strategies: What’s Under The Hood?

· Harry Kat And The Art Of Replicating Hedge Fund Performance

As a practitioner involved in the inclusion of alternative investments and hedge fund programs within a broader portfolio, and more generally also as an asset allocator, I find the evolution of ideas within this area to be both exciting and yet leading to many broad philsophical questions. Where will this lead in terms of the way the largest of defined benefit pension plans think about beta and alpha? Will they think of the asset mix problem differently in the future? I can list other broad questions but the devil is in the details and although many large institutions have already implemented 130/30 type programs, I wonder how hedge fund replication strategies will fit into the mix. For those interested in digging deeper in this area, a further source of information is All About Alpha, a blog I’ve mentioned before also based in Toronto. By the way, Alpha Male, the blogger at AAA will be leading the discussion during for the 2nd panel right after mine.

Update! Last month I commented on some developments here in Canada that saw a closed end fund converted into an ETF. I asked if that was the beginning of a trend.

Maybe not a massive trend, but I now see that First Trust is doing the same with one of their closed end funds. It’s the First Trust Value Line® 100 Fund (FVL) and here’s the press release discussing the conversion. First Trust must really be commended for providing A LOT of information on their funds online.

Unlike the Claymore conversion in Canada that has a truly active manager with a classic active management mandate, the First Trust closed end fund seems to fit the model of other rules-based “quasi-active” ETFs such as their own new AlphaDex funds as well as the IntelliDex and fundamental weighted (FTSE-RAFI) funds both from PowerShares.

The question is if and when we’ll see more traditional closed end funds converting into exchange traded funds? Furthermore, if by doing so, would we hopefully see a minimal spread (premium/discount) between the funds’ market price and the underlying net asset value.  I’m sure that many investors who have exposures to the various country specific funds and thematic funds (infrastructure, for example) on the NYSE would be interested to see a structure, if possible, that would reduce, if not eliminate, this problem with closed end funds.

I’m fairly sure that a part three in this series will follow quite soon.