In May 2007 I put up two posts on this blog related to uranium.  The first was “Uranium Mania” which discussed the astronomical price chart for uranium prices.  One of the easiest ways to gain exposure to the commodity price, as opposed to the producers, is via Uranium Participation Corp (U).  Interesting how that post was written very close to the peak of uranium prices.

At that time, my thinking was that any exposure to uranium would best be accomplished with a combination of U plus Cameco.  Here’s the chart for Cameco over the past three years:

Very different performance patterns between the commodity and one of its major producers.  But it wasn’t until mid-August of last year that Van Eck came out with the first nuclear energy related ETF, the Market Vectors Nuclear Energy ETF (NLR).

For some reason, BGI with its newly listed iShares Global Nuclear Energy ETF (NUCL), must feel like being “second to market” ain’t half bad if the longer term outlook is strong.  I’m posting this blog after having seen this article in Canada’s Financial Post which gives some bullish views given the recently depressed price and a demand situation here in Ontario.  My interest is more related to significant energy policy shifts in the US (regardless of who wins the White House) and even more importantly, the choices made in the emerging world.  The developed world (well, mainly the US) complains about the relative lack of participation of the developing world in environmental policies such as Kyoto.  However, evidence from the annual reports of major uranium producers suggest that the market for them is the emerging world and that’s where they see the future growth.  Who would call that surprising?  Aside from foreign policy roadblocks for concerns that perceived unfriendly regimes would produce weapons grade materials, the necessity for the developing world to access nuclear energy is clear.  How can they compete with the US, China and larger (& more powerful) nations for oil?  I think they need alternative energy sources even more than the big guys.  I’m still a longer term bull for uranium.  The question is whether the exposure should be to uranium prices, the producers or a combination.

Well, aside from Uranium Participation Corp traded in Toronto, there are also uranium futures traded on the NYMEX.  The futures contracted started trading about the same time as my blog from May 2007 … as usual product development seems to be a decent market top provider.  And yes, it’s cash settled … no jokes about delivering 250 pounds of uranium.  That’s about it.  I’m kind of surprised that firms like ETF Securities in London or PowerShares (with their association to Deutsche Bank) haven’t created a uranium price tracker given their expertise in ETFs with futures based underlyings.  It’s just a matter of time.  I’m thinking that it would be nice to have this now and NOT near the next intermediate term top.

To go after the producers, like I said before, we now have two ETFs.  From a year ago, my simplified approach was to put it all in Cameco but for the passive fan, the ETFs would be the way to go.  Since NUCL only came out only about two weeks ago, we can’t do much comparison shopping.

Both have global exposures.  The newer NUCL is about 20bps cheaper in fees but with less holdings at 25 versus 38 for NLR.  The list of holdings for NUCL and NLR show some clear differences in the top 10’s in each as well as proportional weightings.  But what seals the deal for NLR over NUCL is the sector allocations.  Take note that for NLR, the breakdown of the top three sectors is 31% nuclear generation, 29.5% plant infrastructure, 28.8% uranium mining, with the remainder in uranium storage, nuclear conglomerates, uranium enrichment and nuclear fuel transport.  NUCL’s top exposure is in utilities (54.2%).  Their remaining catergory names are relatively generic like “energy”, “industrials” and “financials” (in that order, actually) and so part of their flaw is not doing a better job educating investors on the real uranium sub-sector breakdowns.  Hey, isn’t BGI the experts in ETF education?  You know I just like pickin’ on the big guy.

So, bottom line, this might be a decent time to get in to nuclear/uranium as an alternative energy and emerging market play.  The holdings list does not give enough information on its own so a bit of homework is required to see how much of each name is actually going out to places where energy infrastructure for the longer term is a concern.  Because the uranium producer space is limited to a few big names and many microcaps, it’s a tough call.  Pick a few of the big producers and you’ll do fine but if you’re from the industry or are a commodity freak, hopefully you’ve got some talent in picking the future successful producer (who will likely get acquired by one of the big guys).  Since that’s a tough sport, I think the focus should be on the uranium price for the longer term.  With limited instruments available, the challenge now is to decide between Uranium Participation Corp and uranium futures.  Until, that is, an ETF or ETN for this commodity gets launched.

A couple of weeks ago I was invited by the guys at “The Market Traders” to join in on their weekly roundtable podcast as one of three guest panelists.  If you check out their site, you’ll see that they’re big on commodities.  Possibly a bit more of a speculative bent to their site with ads that make me think that it’s a place where stock pickers come to congregate.  However, I was surprised to find that I wasn’t the only one commenting on ETFs and my fellow panelists didn’t really spend a lot of time discussing specific stocks although a few ETFs were mentioned (not just by me).

We basically comment three times:  Once on energy, the second time on the US dollar and finally with thoughts on areas of the market that we like.  Some who have followed my writings and have become accustomed to the way I do things might be a bit surprised by my final comments.  I basically state in explicit terms how I don’t believe now is a time to think like a traditional asset allocator.  I don’t think now is the time to stick to the “60%-equity/40%-fixed income” strategic asset allocation model.  Frankly, to have a “buy-hold” mentality all of the time requires a stomach of immense fortitude.  (What you are hearing now are people from Vanguard and DFA squirming in their chairs.)  Does that mean I’m leaning towards market timing?  On the spectrum, I don’t think I’m at the far end which is market timing, but I’m certainly not at the buy-hold end.  I’d like to think that the “strategic asset allocation” process which I think is so important (cool with that Vanguard/DFA?) should, in this environment as well as others, be allowed to deviate in two ways:

1.  Allow for some tactical asset allocation.  That may mean allowing min/max constraints for asset classes to deviate even more from “home” or what may be defined as the policy allocation.  That may also mean allowing the asset allocation shifts (rebalancing, delaying implementation of cash equitization, etc.) to happen a little more frequently than normal.  This allowance for tactical decisions could actually mean several things but generally I’m saying that I believe some allowance for deviation from standard asset allocation protocols is warranted.

2.  Allow for exposure beyond the traditional asset mix.  This means to make sure that alternative investment exposures are in place.  Is it too late today for gold, oil, agriculture and other commodities that seem to be getting all the attention these days?  They’re volatile (and I believe, getting more volatile) but their diversification properties are undeniable.  Caveat:  I’m talking about exposure to the commodities via ETFs, ETNs or derivatives, not indirect exposure via equities (like gold producers).  I don’t think it’s too late to get into infrastructure and other inflation hedging asset classes and the only question is how much of these alternative asset classes is warranted as a buffer to the core of traditional asset classes (stocks/bonds/cash)?

Buy-hold philosophies for multi-asset class exposures made a lot of sense for anyone from the period of 1980 to now.  The only major hit was 2000-2002.  The big question I ask myself is whether we are still in this secular up market or did that end one year ago.  In other words, are we in a sideways or down market that has the potential to be anything as bad as the 2000-2002 bear market?  My sense is that for broad regional market exposures like the S&P 500 the answer is likely to be yes.  However, for various sectors and foreign exposures, I feel confident the answer will be no.  We’ve come out of an environment where nearly everything did well fueled by a world of cheap money.  That doesn’t mean that the pendulum will swing causing nearly everything to plummet.

A very important consideration is also the role of private equity and hedge funds given my comments above on the importance of alternative investments.  I can’t stress this enough:  As much as I am a fan of passive instruments, I’ve never said that one should completely disregard active management.  Is it hard to pick the successful managers ahead of time?  Yup.  Do they cost a lot.  More than ETFs and mutual funds but if you’re finding non-correlated returns, they should cost more.  The key question in today environment is what proportion of your portfolio do you want to allocate to market risk and how much to manager risk?

That one takes a bit of time to sink in once you really think about it.

Then you have to ask yourself, is it possible that regardless of which way I choose, it’s likely that the result will be very similar?  In other words, you put all your money in one of two possible portfolios:  All ETFs or all hedge funds … and the result is both go up or both go down!  Of course it’s possible that these portfolios go in opposite directions but that’s what we would expect and that’s why we assume the active-passive proportion decision is important.  But if they go the same way, then we’re likely to lose faith in what we were promised by someone.  The passive route promises very little.  The returns are what the markets provide.  It’s the active route that promises quite a bit more … sometime more than what was provided.  The real bummer is allocating significantly to private equity and hedge funds hoping that they will provide a buffer to the traditional core portfolio of more liquid positions but not reaching that result.  In other words over-promising and under-delivering.

Today’s deleveraged environment provides opportunities but an ever changing landscape for investors travelling the PE/HF path, some good and some bad. We hear of pension funds allocating more and more to many alternative asset classes and strategies.  I wonder if they are pleased or disappointed with their results.  Are the fees worth it?  Are managers providing alpha?  Is the illiquidity constraint more than they bargained for?  Were they too late in making asset mix shifts?  Have they improved their asset/liability situation?

Everyone is talking about credit problems (mortgage, auto, credit card) and the various tentacles of the US economy that are breaking down.  My sense is that it could be as dire as some are stating but the press is likely doing a decent job of sensationalizing the story.  But what about the pension landscape?  Low interest rates plus negative market returns of the past 12 months are bringing us back to the asset/liabiility mismatch situation we first saw during the market slide of 2000-2002.  Are these funds doing so well with their portfolio returns that the relatively low interest rate environment is not causing havoc to their books?  Is this yet another cause for concern for the US financial “infrastructure” landscape?  So many questions and I only wish I could provide simple yes or no answers.  Then asset allocation would be like ordering a pizza.

Despite the volatility we expect to find in international markets and especially in the so-called “developing and frontier markets” (I’m very much not liking those names anymore) there are so many reasons not to have anything but minimal exposure to the US whether it be equities, fixed income or dollars.  Fareed Zakaria’s commonly cited view that one must notice it’s not “the fall of the US” but “the rise of the rest” is important.  It’s important for investors because there’s a parallel to a shift in asset allocation that will surely happen … and it’s already started.  Just how much is an appropriate allocation to the emerging markets?  Defining what is or is not an emerging market or frontier market or even developed market would help in answering this.  But just as important, I believe that the simple move away from “home biased portfolios”, driven by an acknowledgment that intelligent/selective global diversification, is a necessary move in what is likely no longer a simple long-term up market.  Diversification may not be what it used to be, but along with compound interest, it’s one of the very few free lunches we investors have.

Put another way, imagine you are one of the sovereign wealth funds that the press and politicians seem to enjoy commenting on these days.  Recent allocations of these funds to western financial conglomerates (investment banks in need of capital and quickly) is a move to use some of their US dollars to buy relatively cheap assets that will provide some yield (surely negotiated to be better than what others are getting) as well as a buffer to their home grown commodity exposures.  I spend a lot of time thinking about what else is on their shopping list to diversify themselves away from existing commodity and US dollar related risks.  It’s the same exercise any investor should have with their portfolio and the positions held within it.

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.

Just got back from yet another conference and no surprise it covered the current hot topic: commodities.

Speaking of hot, this event was in Dubai. I’ve experienced some hot and humid conditions in my life in places like Manila, Seoul, Singapore and Hong Kong. But this was by far the hottest climate I’ve ever experienced. It was a dry, baking heat. When outdoors, finding shade helped and certainly the buildings had great air conditioning. But, for example, I had my cousin who lives in the city take me around the gold (souk) market. Getting out of the car into the sun was incredible. It felt just like a dry sauna. And they say it’s just the beginning of the hot season! Luckily, the hotels, office buildings and shopping centres are all so luxurious that climate does not have to be a concern. With most taxis I rode in being a Lexus, you get a sense of what this city is about. Never mind the Burj Al Arab hotel, indoor skiing and other obvious signs of excess.

A quick comment on the souk. It’s all about gold there. Prices are quoted daily and there are people buying. I wish I was in Dubai six months ago and a year ago to get a handle on the number of people transacting. A good sign was at the retail section of the Dubai airport (departure section). They had a gold merchant right at the centre when you pass through the last security checkpoint (I think my carry on luggage was scanned only twice which is hopefully enough). Unlike the real souk market which was not empty but certainly not busy, this place was packed! And people were really buying. They didn’t look like momentum traders nor supermodels but everyday travelers. Maybe they know that gold is back to where it was near the beginning of the year:

Or more likely, maybe they new better than me than to take the heat and walk the outdoor souk.

From the moment you cruise into Dubai International or drive into downtown, you can’t help but notice the construction. It beats Las Vegas, Miami and other real estate bubble regions of the US. It kind of reminds me of Seoul when I first went there as a youngster in 1979. My bet is that Dubai will want to host an Olympics … but they’re held in August and if that’s still the hot season I just don’t know who could survive the marathons, triathlons and other outdoor events. Still, you can’t help but sense the feeling of ambition in Dubai. For some reason, a lot of the new buildings going up have the number of floors in the triple digits. Excess is a relative term when you’re in Dubai. The sense on the ground is that the construction boom is in full throttle but not anywhere close to the bubbly stage. But I can’t get my mind off the fact that a lot of the construction is done at night when the temperatures are simply cooler. It’s the endurance of the migrant workers who have the day shift that I find quite astonishing. Think of the pyramids in Egypt and the Yucatan, the Taj Mahal and other larger-than-life structures and the same can be said for the city of Dubai. The super-skyscraper “Burj Dubai” was front and centre from my hotel room window. I can’t remember and certainly could not even count the number of cranes working throughout the day and night when viewing the skyline. Part of the view is filled with very unique and certainly luxurious looking buildings, but among them were cranes working on competing structures. The success story that is the UAE is of course based on the decision of its leaders to diversify beyond oil. But the structures we see being built today, like the pyramids of the past are built from the labors of a massive force that are too often left forgotten. I think that in today’s world when we think about gold and oil, the supply/demand imbalances are often cited as being driven based on what’s happening in the emerging world. That’s certainly true, but the commodity that is labor is certainly a key factor as well and you can see that when driving by any construction site in Dubai. Of course, think of the factories in coastal China and the low cost IT worker in Bangalore and you quickly get the story of the emerging markets.

An important point to make on this is the importance of the success of the emerging markets in aggregate. It simply has to happen. Jeremy Siegel at Wharton wrote a paper in the September 2007 Financial Analysts Journal titled “Impact of an Aging Population on the Global Economy”. To summarize one of its key conclusions I begin with a simple fact: The western world is aging and it can’t eat its financial assets during its retirement stage. Much has been said of an equity market depression should the boomers sell their equity investments as a whole even if it’s spread out over several decades. Siegel’s paper articulates the fact that the growing middle class of the emerging world can be a very significant group that buys these financial assets. As individuals, they may not have much residual assets left for savings and investment, but in aggregate the numbers can and likely will be in their favor. This logic makes sense and our only hope is that the typical worker from the emerging markets does not go berserk with their discretionary spending and adopt a savings rate similar to many in the west. Furthermore, we have to hope that the western world does not adopt a protectionist stand. We see the beginning of potential trouble already. How do most Americans (never mind their government) feel about some sovereign wealth funds buying significant parts of major Wall Street financial conglomerates? What about if the same happens to media firms, utility companies and certain defence/high tech firms? Much of Western Europe isn’t happy with the rising growth of mosques versus churches across the continent. Will religious as well as racial discrimination hamper the transfer of wealth, and as important, capital investment? I think that the factors driven by demographics are so strong that any reasonable person or society will figure out what measures are required in order to survive. Unfortunately, the short-term horizon of politicians often conflict with this simple assumption.

Getting back to this commodities conference, the overall turnout was a bit of a disappointment but what was especially poor was the level of institutional investors in attendance. I couldn’t find one. Luckily I had meetings set up for me prior to traveling or this would have been a rather uneventful trip. One observation that I made was the fact that despite this being a commodities event in a growing part of the emerging markets, on day one of this conference all sessions except for one made some reference to indexing, passive investing or the use of ETFs. I did not attend day two and so I can only wonder if this fact remained true. Now I know that most of the discussion revolved around the active use of ETFs and/or derivatives but this still strengthens my case that the ETF story is not only strong but expanding globally. I think that the saturation we see today in the US will grow to many other regions. However, it’s still early. Today, there are no ETFs domiciled in Dubai. Great fanfare has been made about Dubai as the financial centre bridging the time gaps between the financial centres of Europe and East Asia. It will only be a matter of time before Dubai becomes a hub for derivatives and ETFs. From my travels, I see a parallel between ETFs (or financial services products in general) and airports. The US and Europe are full of busy yet aging airports. The emerging world is now making waves about their fancy new and relative large airports, albeit in much smaller numbers. I think the ETF industry will expand to these same regions with a few but relatively large (by asset levels) offerings in the not too distant future. Who knows what the expansion will be like thereafter. I don’t see a duplication of what has happened in the US but perhaps something fairly close in a few markets. We’ll see how the BGI’s, SSGA’s and other ETF providers do in entering these markets to compete with the local providers.

By the way, I’ve mentioned that the ETF industry within the region is still sparse. However, we’re not much better here in North America. The SPDR S&P Emerging Middle East & Africa ETF (GAF) is all we have now.

Not exactly the greatest diversifier but the high correlation story is one you’ve heard from me enough times I’m sure.

An interesting tone I sensed at this conference and confirmed at my meetings was some urgency in terms of dealing with the commodity complex. The need for active management was clear. Most would agree that a “buy-hold” mentality just doesn’t make sense for this highly volatile asset class. This would be true not just for a diversified (index-like) exposure but also positions in specific sub-indices (agriculture, metals, energy) or direct single commodity exposures. Despite the fact that so many commodity tracker funds have been launched in recent months and years, it looks like the need for them is very high indeed.

If you were to ask an investor what was their main reason for commodities exposure, you’d get a variety of answers. This may be true for any stock, hedge fund or asset class but I’m very interested in those given for commodities: inflation hedge, low correlation to other major asset classes, macroeconomic rationale given growth of emerging markets and relative dormancy in 1980’s and 90’s, demise of US dollar. These are all risk based rationale but for whatever reason, it seems like there’s a vast array of investors jumping on the Jim Rogers bandwagon. This includes the many ETFs, ETCs and ETNs that have hit the market over the past few years with exponential growth both in terms of numbers and assets. Should there be cause for concern that these new assets are helping fuel the fire? I think so as it will likely lead to greater volatility both up and down. Don’t get me wrong, even without all these new commodity tracker funds, I’m still in the camp that we’re in a long secular bull market albeit with the strong possibility of down markets (drops of 20% easily) with the possibly of not regaining new highs until at least six to twelve months if not longer. The question is whether the magnitude of drops and time to recovery are magnified due to ETFs and related instruments. I can’t help but think so.

And the main reason why I think this is so is just from considering who would be using these commodity trackers. The big user has to be the hedge funds which for me includes managed futures/CTAs. Don’t have anything against them. My first job in the industry was basically in this space although the focus was squarely on equity indices. Just like quant funds that were quite synchronous (unfortunately to the down side) in the late summer of 2007, I could see CTAs herding in and out of the broad commodities complex to capture the major up and down markets … I’m not saying they’ll all move in line to day-to-day volatility.

This excess momentum due to mass herding is what angers the emerging countries when they consider the foreign “speculators” (not “investors”) getting in and out of their market. That’s one of the prices of capitalism. The key, like we see in Dubai, is to find the long-term story. Dubai and other countries in the GCC region and beyond will not only survive but evolve into a longer term success story based on their ability to reap the rewards of this high oil price period (or “era” depending on how long this lasts). My hope is, just as South Korea copied the Japanese model through a well educated workforce and strongly industrialized infrastructure, the neighboring countries in the gulf and the broader MENA region can duplicate some of the success of Dubai. We can see some of this already in Bahrain and Qatar but there needs to be more.

Final thought on Dubai. I had dinner with a gentleman in the industry and asked what model Dubai used for its success to diversify beyond its core asset. My guess was Hong Kong but he said it was Singapore. Makes sense since Singapore is a bit more diversified in terms of having had greater labor requirements in the past (not so much today) from abroad to help build its infrastructure whether it be engineering, financial or otherwise. Singapore definitely has a more culturally diverse population than Hong Kong or any other Asian city I can think of. In this regard, I can’t help but think that the commodity that is often left unconsidered or, at best, overlooked is labor. Where will the migrant worker move to next? Where can one find skilled or at least partially skilled labor? I heard of the incredible housing and food inflation in the UAE and I wonder how that effects the laborer at the very bottom of the ladder. Probably not well but it’s certainly better than their prospects at home. Still, on one of my comfortable taxi rides, I saw a bus packed full of workers … something I’ve seen in countless other cities but I could see that conditions for them were not good. Not to pick on Dubai, but I wonder how fair their labor laws are for immigrant workers. This question is easily applicable to other booming economies that have significant immigrant populations and the debate in the US on this subject is an appropriate example even though their economy, nor its outlook in my opinion, could not be described as booming. This trip was certainly an eye opener for me. The chance to see and feel the luxury was nice but I’m glad I was able to observe a bit of the other side although from far away. Cliche as it it may be, I think it’s Pierre Trudeau who first said something to the effect that you really don’t appreciate the value of Canada until you’ve traveled the world. It’s certainly not meant to be an insult to Dubai - clearly one of the great success stories of the emerging world and especially within a volatile region - but I find it interesting that after this trip I realized just how great Canada is. Maybe it’s also the fact that we get roughly ten days at most of 40 degrees Celsius heat or worse a year.

I spent some time today with my wife and daughters at the park with warm sun and a cool breeze. Perfect weather.

I keep telling myself, and the occasional inquirer, that I’ll get back into serious blogging … or at least publish at a pace similar to when I started back in 2006. Clearly, you will have noticed that that ain’t happening. One of the things that has kept me busier in recent times has been conference speaking. Just earlier this May I was at Connex International’s Public & Private Wealth Group Forum, an institutionally focused event with both a pension track as well as an endowment/foundation track.

To no surprise, there was a lot of content revolving around the use of alternative investments of all sorts but especially hedge funds. I was most interested in discussions related to emerging markets as, to me at least, it seems like this is an area where in the longer term there would be a fair assumption for double digit returns unlike other broad asset classes and strategies. The downside of course is the volatility but for long-term oriented institutions, that shouldn’t be a problem given appropriate diversification and risk budgets. However, the overall sense I had from this and other events in recent months was that emerging market investing is still in the early “toe dipping” stage. Never a good time to get in like when it’s nearly too late! I think it’s far from too late … in fact I think it’s still relatively early. But it’s this herd mentality that I believe is hampering the performance of many institutions. Perhaps the people working at conservative institutional funds just aren’t compensated in a way that would allow them to deviate from what would be perceived as “industry norms”.

Of course, the same could be said of the herd mentality of all investors including retail individuals and their financial advisors. What once was about picking stocks has now moved well past chasing managers with mutual funds to chasing markets via ETFs. Is Kang bashing ETFs?!!! Well, yeah in a way but everyone knows that the gold market and other peaky, speculative (pick an adjective) market has likely had its volatility juiced up due to the level of increased participation of everyday investors thanks to ETFs. Whether it’s good or bad is not for me or anyone to say … in any market that sees more speculators come in versus long-term investors it’s common to find more instruments to feed the frenzy. Remember all the tech and Nasdaq funds in 2000?

The whole concept of alternative investments is a bit of a conundrum to me. At the one end, it’s a reality that has to happen given the limitations of traditional investments. Having a vanilla portfolio of stocks, bonds and cash can only get you so far. So called “couch potato” portfolios sound good but when the markets are going against you, the tendency will be to take action at the very worst time. I didn’t even say that the action would be right or wrong; I’m just saying that the timing will likely be off. If the decisions of what to sell, what to buy, what to hold, whatever, are also off … well, no one does well in college or at their job by being a couch potato.

Correlations among asset classes and strategies remain high. The search for low correlated alternatives will evolve in time but this search for the next new market will persist. The frontier markets of today will be the emerging markets and then developed markets of the near future. Technology, high educational standards internationally and the globalization of economies and capital markets will see this transformation process increase pace exponentially.

The low yield environment of today is another reason alternatives are hot. The traditional fixed income market just isn’t enough. And that includes inflation adjusted bonds where we’ve recently seen the TIPS market hit some interesting numbers (zero).

If we’ve now entered something similar to the beginning of the decade (negative returns with low interest rates), then we’re back to the deadliest of combinations for pension plans and their asset/liability mismatch predicament. With low interest rates, the present value of their liabilities increase so that, on paper … well let’s just say, GULP. Not good. The honest knee jerk reaction from some along with, of course, thoughtful debate and consideration by many others will be to increase allocations to all sorts of alternative investments. It would surprise me immensely if hedge funds and real estate did not get the biggest chucks of these new allocations. My hope is that these alternatives, no matter what they are, provide a true “risk reduction” function for portfolios as opposed to simply a “return enhancement” function. I believe the period of early 2003 to mid 2007 was the time for thinking about return enhancement.

With regard to thinking about risk, I now refer you to three videos that were made immediately after an appearance I made in Las Vegas earlier in April. I was speaking on global investing at the 5th Annual Las Vegas Financial Advisor Symposium thanks to the organizers at InterShow and an invitation from the panel moderator and fellow blogger, Tom Lydon. FYI: Equally cool and insightful blogger, Roger Nusbaum, was also a panelist with me on stage. It’s clear that moving from a US-centric portfolio to one that is more international (with a significant dash of emerging market exposure) is key to improving risk adjusted returns for long-term investors. The concern is implementation and keeping intelligent diversification a key directive. Anyway, the evolution of ETF industry to active management, emerging markets exposure and risk management are the main topics from the three videos. Clicking on the still shots below will lead you to InterShow’s site and the videos [Sorry for having to make you leave this site and come back for each video but there was no allowance for me to embed the videos on my site … traffic matters].

Evolution in ETF Industry:

Emerging Markets:

Risk Versus Return:

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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.

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.

Interesting finding in the Globe and Mail’s Streetwise blog where Andrew Willis provides news of an upcoming IPO for GHG Emission Credit Participation Corp. on the Toronto Stock Exchange. Willis mentions that this is a pure play into the carbon emissions market similar to other funds on the TSX that provide pure play exposure to gold, molybdenum and uranium. I’ve mentioned Uranium Participation Corp. (U) as a unique and easy means to uranium price exposure however there are now futures for this commodity as well.

This press release give a bit more on the IPO.

Technically neither of these “Participation Corp.” (uranium and now emission) instruments are ETFs but they are traded on an exchange like a stock and for the vast majority of investors do the job of providing indirect commodity exposure as GLD and SLV do for gold and silver respectively.

I’ve discussed carbon markets in the past and some googling will provide more background information … more than you need, of course. I find Wikipedia may not be the most reliable source of information for a particular subject, but it usually provides a decent set of links and this is true when you look here and here.

Not surprisingly, there’s also news of problems in this new space. Fertile ground for active managers.

Another interesting angle is to explore getting a piece of the infrastructure by purchasing shares in Climate Exchange PLC (CLE) which is covered in the topmost link as well as in this National Post article.

For the large institutional investors, I’d speculate that they would gain exposure to emission markets through hedge funds. Frankly, I would be surprised if internal managers in even the largest pension funds included direct carbon instrument exposures within their GTAA programs. For most investors, this market is still in its infancy and therefore getting in quick and easy may be the best approach simply for practical reasons. Alternative energy will be hot for a long while and emissions may be the next uranium. Perhaps exposure to the market itself through GHG Emission Credit Participation Corp. as well as to the exchanges through Climate Exchange PLC should provide more than enough of an allocation replacement should uranium investors decide to take their profits and move on.

Many observers of the ETF industry have commented on the thinner slices to sector exposures provided by fund manufacturers in recent years. My take is different. Although there are some “sectors” that are indeed quite narrow, many new fund offerings are more “thematic” in nature. These include water, alternative energy and infrastructure and are more broad that they are, in my opinion to be considered asset classes themselves. Of course, some would consider this issue semantics but that’s for the final user to decide within their own investment process. Certainly, many institutional investors look at infrastructure as an asset class. I don’t know if I would consider water to be an asset class … actually, I don’t … but it certainly is broader than a sector and can be considered thematic in nature.

At the end of the day, I am interested in finding things (call it a sector, call it a theme, I really don’t care) that help in the overall risk-adjusted return potential for any given portfolio. I think Van Eck is a firm that thinks the same way. Steel company exposures (through their Steel ETF, SLX) may not be a diversifier for many, but I could see it as one for many unique types of investors. The same could be said for their Environmental Services ETF (EVX), their Gold Miners ETF (GDX), their Global Alternative Energy ETF (GEX) and their new Russia ETF (RSX).

To take RSX as another example, for an investor with a need for emerging market exposure outside of what they likely already hold (China, India, EEM) and with a strong commodity bias, this fund makes sense. For someone like a Canadian or Australian, it likely doesn’t make so much sense.

But now I’m getting word of some new ETF product development in the Van Eck pipe as seen from this recent SEC filing.

What have we here? (Think Lando when he first met Leia for all the fellow Star Wars geeks out there.) Here are some of the more interesting excerpts:

Market Vectors—Global Agribusiness ETF and Market Vectors—Global Nuclear Energy ETF (the “Funds”) are distributed by Van Eck Securities Corporation and seek to track the DAXglobal^® Agribusiness Index and DAXglobal^® Nuclear Energy Index, respectively, each of which is published by Deutsche Börse AG (“Deutsche Börse”).

More specifically on the Agribusiness ETF:

MARKET VECTORS-GLOBAL AGRIBUSINESS ETF

Principal Investment Objective and Strategies

Investment Objective. The Fund’s investment objective is to replicate as closely as possible, before fees and expenses, the price and yield performance of the DAXglobal^®® Agribusiness Index.” Agribusiness Index (the “Agribusiness Index”). For a further description of the Agribusiness Index, see “The DAXglobal^® Agribusiness Index.”

Principal Investment Policy. The Fund will normally invest at least 80% of its total assets in equity securities of U.S. and foreign companies primarily engaged in the business of agriculture. Companies primarily engaged in the agriculture business include those engaged in agriproduct operations, livestock operations, agricultural chemicals, providing or transporting agricultural equipment, and providing or transporting ethanol/biodiesel, and which derive at least 50% of their total revenues from such activities. This 80% investment policy is non-fundamental and requires 60 days’ prior written notice to shareholders before it can be changed.

Indexing Investment Approach. The Fund is not managed according to traditional methods of “active” investment management, which involve the buying and selling of securities based upon economic, financial and market analysis and investment judgment. Instead, the Fund, utilizing a “passive” or indexing investment approach, attempts to approximate the investment performance of the Agribusiness Index by investing in a portfolio of securities that generally replicate the Agribusiness Index.

The Adviser anticipates that, generally, the Fund will hold all of the securities which comprise the Agribusiness Index in proportion to their weightings in the Agribusiness Index. However, under various circumstances, it may not be possible or practicable to purchase all of those securities in these weightings. In these circumstances, the Fund may purchase a sample of securities in the Agribusiness Index. There also may be instances in which the Adviser may choose to overweight another security in the Agribusiness Index, purchase securities not in the Agribusiness Index which the Adviser believes are appropriate to substitute for certain securities in the Agribusiness Index or utilize various combinations of other available investment techniques in seeking to replicate as closely as possible, before fees and expenses, the price and yield performance of the Agribusiness Index. The Fund may sell securities that are represented in the Agribusiness Index in anticipation of their removal from the Agribusiness Index or purchase securities not represented in the Agribusiness Index in anticipation of their addition to the Agribusiness Index. The Adviser expects that, over time, the correlation between the Fund’s performance and that of the Agribusiness Index before fees and expenses will be 95% or better. A figure of 100% would indicate perfect correlation.

The Fund will normally invest at least 95% of its total assets in securities that comprise the Agribusiness Index. A lesser percentage may be so invested to the extent that the Adviser needs additional flexibility to comply with the requirements of the Internal Revenue Code of 1986, as amended (the “Internal Revenue Code”), and other regulatory requirements.

Because of the passive investment management approach of the Fund, the portfolio turnover rate is expected to be under 30%, generally a lower turnover rate than for many other investment companies. Sales as a result of Agribusiness Index changes could result in the realization of short or long-term capital gains in the Fund resulting in tax liability for shareholders subject to U.S. federal income tax. See “Shareholder Information—Tax Matters.”

Market Capitalization>. The Agribusiness Index is comprised of companies with market capitalizations greater than $150 million that have a worldwide average daily trading volume of at least $1 million and have maintained a monthly trading volume of 250,000 shares over the past six months. The total market capitalization of the Agribusiness Index as of [ • ], 2007 was in excess of $[ • ] billion.

So we now have a competitor to the up to the PowerShares-Deutsche Bank agriculture ETF (DBA). A quick review from its website gives us this description:

The PowerShares DB Agriculture Fund is based on the Deutsche Bank Liquid Commodity Index – Optimum Yield Agriculture Excess Return™ and managed by DB Commodity Services LLC. The Index is a rules-based index composed of futures contracts on some of the most liquid and widely traded agricultural commodities – corn, wheat, soy beans and sugar. The index is intended to reflect the performance of the agricultural sector.

With all the focus on metals and energy, diversifying into agriculture is a reasonable move for investors with the size to spread their allocations out even further. Those who lean more towards a Jim Rogers philosophy will look to DBA and/or this new Van Eck offering as more of a strategic (I would say tactical) bet.

And like applying a GLD/GDX combo for exposures to both the gold bullion price and gold miners, a similar DBA/new Van Eck combo makes sense here. For those implementing a position to a specific commodity, I think this dual positioning is ideal and the tilting between the two positions can be a significant source of alpha in the long-term (in my opinion). If only this were also available to the commodity I’ve been commenting on recently and for quite some time: uranium.

More specific to the upcoming Nuclear Energy ETF from Van Eck:

MARKET VECTORS-GLOBAL NUCLEAR ENERGY ETF

Principal Investment Objective and Strategies

Investment Objective. The Fund’s investment objective is to replicate as closely as possible, before fees and expenses, the price and yield performance of the DAXglobal^®® Nuclear Energy Index.” Nuclear Energy Index (the “Nuclear Energy Index”). For a further description of the Nuclear Energy Index, see “The DAXglobal

Principal Investment Policy. The Fund will normally invest at least 80% of its total assets in equity securities of U.S. and foreign companies primarily engaged in various aspects of the nuclear energy business. Companies primarily engaged in the nuclear business include those engaged in uranium mining, uranium enrichment, uranium storage, providing equipment for use in the provision of nuclear energy, nuclear plant infrastructure, nuclear fuel transportation and nuclear energy generation, and which derive at least 50% of their total revenues from such activities. This 80% investment policy is non-fundamental and requires 60 days’ prior written notice to shareholders before it can be changed.

Indexing Investment Approach. The Fund is not managed according to traditional methods of “active” investment management, which involve the buying and selling of securities based upon economic, financial and market analysis and investment judgment. Instead, the Fund, utilizing a “passive” or indexing investment approach, attempts to approximate the investment performance of the Nuclear Energy Index by investing in a portfolio of securities that generally replicate the Nuclear Energy Index.

The Adviser anticipates that, generally, the Fund will hold all of the securities which comprise the Nuclear Energy Index in proportion to their weightings in the Nuclear Energy Index. However, under various circumstances, it may not be possible or practicable to purchase all of those securities in these weightings. In these circumstances, the Fund may purchase a sample of securities in the Nuclear Energy Index. There also may be instances in which the Adviser may choose to overweight another security in the Nuclear Energy Index, purchase securities not in the Nuclear Energy Index which the Adviser believes are appropriate to substitute for certain securities in the Nuclear Energy Index or utilize various combinations of other available investment techniques in seeking to replicate as closely as possible, before fees and expenses, the price and yield performance of the Nuclear Energy Index. The Fund may sell securities that are represented in the Nuclear Energy Index in anticipation of their removal from the Nuclear Energy Index or purchase securities not represented in the Nuclear Energy Index in anticipation of their addition to the Nuclear Energy Index. The Adviser expects that, over time, the correlation between the Fund’s performance and that of the Nuclear Energy Index before fees and expenses will be 95% or better. A figure of 100% would indicate perfect correlation.

The Fund will normally invest at least 95% of its total assets in securities that comprise the Nuclear Energy Index. A lesser percentage may be so invested to the extent that the Adviser needs additional flexibility to comply with the requirements of the Internal Revenue Code and other regulatory requirements.

Because of the passive investment management approach of the Fund, the portfolio turnover rate is expected to be under 30%, generally a lower turnover rate than for many other investment companies. Sales as a result of Nuclear Energy Index changes could result in the realization of short or long-term capital gains in the Fund resulting in tax liability for shareholders subject to U.S. federal income tax. See “Shareholder Information—Tax Matters.”

Market Capitalization. The Nuclear Energy Index is comprised of companies with market capitalizations greater than $150 million that have a worldwide average daily trading volume of at least $1 million and have maintained a monthly trading volume of 250,000 shares over the past six months. The total market capitalization of the Nuclear Energy Index as of [ • ], 2007 was in excess of $[ • ] billion.

Perhaps the whole green ETF thing has gone a bit far in the past year but, a bit surprisingly, this would be the first pure play on the nuclear energy story. I have commented recently on uranium as have so many other industry watchers in recent months after having seen the commodity double in price in the past four calendar years … it’s up roughly 70% so far this year according to the chart found here.

I just said “pure play”, but it’s important for prospective investors to consider the 50% and 80% values quoted in the above descriptions. That’s 50% of the revenue of an underlying holding must fit the required parameters and 80% of the fund’s assets is to be invested in companies whose primary business operations are in the field of agriculture or nuclear energy respectively.

I don’t want to comment too much on this nuclear energy ETF as I don’t have enough information at this time. But here’s the problem I foresee: There’s just not an even spread of companies involved in the nuclear energy business. Let’s take uranium mining for example. It’s Cameco (CCJ), a very small number of competitors who are close in terms of size and a large number of small cap, if not micro cap, producers. Having an ETF based just on uranium miners would be a logistical nightmare and investors would have to accept a few stocks dominating the fund. An equal weighted ETF for this sector would make sense except for the fact that the thinly traded smallcaps/microcaps would provide an interesting (to say the least) situation for the market makers of the fund. I could see hedge funds getting into that game on the other side. We can only hope that there is a more robust mix in other related businesses mentioned in the prospectus namely uranium enrichment, uranium storage, providing equipment for use in the provision of nuclear energy, nuclear plant infrastructure, nuclear fuel transportation and nuclear energy generation.

In the past I’ve mentioned both Cameco and Uranium Participation Corp (U) as appropriate uranium plays. This new nuclear energy ETF would be an even more appropriate holding in the place of Cameco and with recent uranium derivatives on the market, exposure to the price of uranium itself allows for more complete exposure (and inverse through shorting) than in the past.

No word yet on fees as well as other details on these upcoming Van Eck ETFs.

I’d say that of all the ETF providers, it’s the news out of Van Eck that gets me the most interested and I always look forward to finding out what’s next from them.  Nothing too fancy … just new exposures, but I like it!