It’s interesting that a lot of innovation in the ETF space has come out of Canada. We’re like an incubator of ideas before the full rollout of products occurs in the US and globally. Below I discuss some new offerings to this market. They may prove to be clues of similar offerings that could soon appear in your jurisdiction.Up here in Canada, the ETF market is dominated by Barclays Global Investors. Recently BGI rebranded their ETF lineup from iUnits to iShares, similar to their ETF family in the US. DFA has had a presence here as well since 2003. TD Asset Management (a subsidiary of TD Bank) had a short attempt at the industry with a small family of ETFs. With a broad composite, as well as value and growth tilts on it, I thought these funds had a decent shot at building a following. It didn’t happen. My feeling is that the Canadian market is not that big, certainly not big enough to sustain too many ETFs. Still, as we’ve seen globally, ETF investing is gaining significant ground here.

Enter Claymore Investments (“Claymore”), a Canadian subsidiary of the Claymore Group out of Chicago. As I reported on June 20th, Claymore has teamed up with Rob Arnott’s Research Affiliates to bring fundamental indexation to Canada. Claymore now plans on launching 6 new ETFs in the following areas:

· Global Fundamental Indexation

· US Fundamental Indexation

· Japan Fundamental Indexation

· Oil Sands

· BRIC (Brazil Russia India China) and

· Dividend & Income

Like the Canadian Fundamental ETF, the new Claymore ETF FTSE RAFI products have a 65bps MER. The other 3 ETFs have a 60bps MER. Interestingly, Claymore has a 2nd class of ETF called “Advisor Class Units.” This tacks on 75bps as an annual service fee (in Canada, we call it a trailer fee) payable to the client’s advisor. A couple of thought on this fee structure. First, it allows Claymore’s offerings to have broader appeal, at least for those who are involved in selling financial products. Specific to Canada, I remember learning from DFA that their class of funds with similar trailer fees was a new company development tailored for the Canadian market. I believe that the Canadian marketplace is still behind the curve when product developers have to provide incentives to sell their products where such incentives are not required in other jurisdictions.

For global readers, I believe that the significance of the new fundamental weighted ETFs is further proof of the growth of non-market cap indexation. It’s too early to say whether or not fundamental indexation is a fad. Anything can happen, and like TD’s ETFs in Canada, any ETF without a large size of assets under management can quickly be shut down. However, I can only imagine that Rob Arnott as well as the guys from WisdomTree are making their rounds globally trying to spread their wares. The evidence is compelling: Moving away from cap weighted indexation, whether towards Arnott, Siegel or Fama/French, provides better risk-adjusted returns.

Now let’s focus on their last three ETFs. First, the oil sands. I don’t think this one is late to the market but my feeling is that every Canadian already has a position or ten in this sector. BGI Canada has an ETF that tracks the S&P/TSX Energy sub-sector (XEG), has a real track record of about five and a half years and with the usual oil sand majors well represented. Still, it’s true that there is no ETF specifically for the sector. The market will decide if one is needed.

Similarly, BGI has a dividend and income ETF even though it’s only about seven months old. It tracks the Dow Jones Canada Select Dividend Index. Although Claymore’s offering tracks a different underlying index (Mergent’s Canadian Dividend & Income Achievers Index), I’ll be eager to learn what are the overall yield targets and see how historical backtests compare in terms of volatility of returns. I would be surprised to see much difference between the two.

According to my contact at Claymore, this is the first BRIC ETF in the world. A lot of people have been waiting for this. Its planned launch is August 15th. It is based on the ADR’s that trade in the US, which limits liquidity concerns and local market issues. Also, the ADRs are only issued by companies that are regulated by the SEC. This is good in terms of dealing with companies that follow standardized accounting practices but clearly eliminates a lot of companies in these countries. Of interest only to Canadians is that the US$ currency from the ADRs will be hedged to eliminate the FX risk. Of interest to American and other investors is that a US domiciled version should be not too far behind.

The portfolio has roughly 70 holdings. Country breakdown is currently 50% Brazil, 30% China, 15% India, and 5% Russia. Since ETFs already exist for Brazil and China, I would be happier if larger allocations were given to India and Russia.

Industry Breakdown is:

Energy 29.33%

Telecommunication Services 16.28%

Financials 16.17%

Materials 14.91%

Information Technology 9.47%

Industrials 4.36%

Consumer Staples 4.15%

Utilities 3.35%

Consumer Discretionary 1.43%

Health Care 0.55%

My only concern with the BRIC ETF is the same I have with EEM. Another play on the commodity complex?! EEM’s chart looks a lot like that of an energy sector ETF. As time passes, I think I want to be dialing down, not up, on my overall commodity exposure. I’m still completely bullish on commodities, although maybe not like Jim Rogers, but I’m always thinking about how much of my portfolio is “commodity sensitive”, especially considering the flaw of “home bias” and thus how much our clients have in the Canadian market which is nearly 50% energy/materials. The dialing down of commodities may not be happening soon but I am simply cautious now of adding more.

What would really interest me is a product offering that combines the concept of BRIC investing with specific sectors that just make sense for these areas. For example, what about an infrastructure fund investing primarily in the BRIC countries? This would certainly be an actively managed fund so I”ll stop there.

As a professional manager, I’m happy to see the added fundamental weighted ETFs as potential core asset class positions. The BRIC ETF could be a nice add-on to the international equity lineup of EFA/EPP/EEM. However, with the still relatively young Canadian ETF industry, not in terms of years but in terms of assets and trading volumes, I will be somewhat cautious. With increased trading volumes I will become more comfortable in implementing these positions.

But what this industry really needs is greater acceptance of new entrants. This includes Claymore in Canada as well as WisdomTree, ProShares and Powershares in the US. Nothing against BGI, but maybe as an owner/operator of a small shop myself, I cheer for the small guy. BGI certainly has been an innovative provider in the past with new ETFs for more diverse asset classes but it’s the new small providers that have become the new innovators. Are they bringing too many products for the markets? Let the market decide. Some may become a BGI. Some may become a TD.

S&P has been publishing their Standard & Poor’s Indices Versus Active Funds Scorecard [SPIVA] results long enough for investors to understand that indices beat comparable funds more often than not. Fees and the costs of implementation are the main culprits for the difference. Really, the comparison should be with similar ETFs, not the index. What is interesting in the latest SPIVA report from July 19th is that S&P has extended their work into international equities, including emerging markets. This is an area where many observers have commented on the outperformance of active managers versus their respective benchmark. Here are some comments from their press release related to the results of international equities from the report:

International Equities

SPIVA now reports on the performance of international funds versus their relative international S&P benchmark. For the first half of 2006, the SPIVA scorecard shows that indices outperformed actively managed funds. The S&P/Citigroup PMI outperformed 59.7% of global equity funds, the S&P/Citigroup PMI World ex U.S. outpaced 62.5% of international funds, the S&P/Citigroup EMI World Ex U.S. outperformed 63.3% of international small-cap funds, and the S&P/IFCI Composite outperformed 80.9% of emerging market equity funds. Similar to domestic equities, international indices outperformed actively managed funds over a three- and five-year basis.

While indices have historically outperformed actively managed domestic equity funds over long periods of time, our report provides the first evidence of this being true for fixed income and international equity funds,” says Srikant Dash, Index Strategist at Standard & Poor’s. “Even in relatively inefficient asset classes, such as Emerging Market Equities and High Yield Bonds, a majority of active funds underperformed benchmarks over five-year horizons.

Wow. 81% of emerging market equity funds underperformed the index. I’d like to know what the number is versus something like the MSCI EM Index. 81% just seems so big to me, but it really was a very bad May and June.

From the looks of it, core holdings for international equities should still be:

· Broad EAFE exposure: EFA or a combination of VGK/VPL
· Emerging market exposure: EEM or VWO
· Also watch to see what comes down the pipe from PowerShares (FTSE/RAFI) and WisdomTree

It’s looking more and more like we have to move towards a “portable alpha” world. If these numbers are correct, even emerging markets is an asset class where a passive instrument may make more sense than an active manager in the long run… or at least hold more ETFs than managed funds. Truly alpha oriented (beta-neutral) strategies, if they really exist after fees and are repeatable, is the only domain left for active management.

Otherwise, investors will have to become more like pension funds and give up liquidity to enter areas like infrastructure, timber, private equity and other alternative investments.

Given the market action, I’d like to continue on my focus on defensive measures (inverse ETFs, VIX, cash balances, etc.). Today, I received a notice from Business Wire regarding new options on some very interesting ETFs:

The Chicago Board Options Exchange today announced it will list options on the following five ETFs beginning today: First Trust IPOX-100 Index Fund (AMEX and CBOE ticker symbol FPX); iShares FTSE/Xinhua China Index Fund (NYSE and CBOE ticker symbol FXI); Market Vectors Gold Miners (AMEX and CBOE ticker symbol GDX); Powershares Wilderhill Clean Energy (AMEX and CBOE ticker symbol PBW); and Powershares Water Resources Portfolio (AMEX and CBOE ticker symbol PHO).

The Designated Primary Market Makers [DPM] for the options are as follows:

First Trust IPOX-100 Index Fund (FPX)
DPM: Jane Street Specialists

iShares FTSE/Xinhua China Index Fund (FXI)
DPM: Jane Street Specialists

Market Vectors Gold Miners (GDX)
DPM: Jane Street Specialists

Powershares Wilderhill Clean Energy (PBW)
DPM: Susquehanna Investment Group

Powershares Water Resources Portfolio (PHO)
DPM: Susquehanna Investment Group

For more information on new listings, visit the Trading Tools section of the CBOE website at: http://www.cboe.com/NewListings.

Frankly, I’m not a big fan on the first two of these ETFs. FPX is unique in concept but as an risk/asset allocator, it’s hard to see how this fits in the overall portfolio construction process.

For me, there are just so many better choices to play China than FXI. Although a big believer in ETFs, China has to be one area where an active manager has a more than decent shot of beating a comparable benchmark index. Also, the costs of FXI don’t justify what’s in the fund. I think that instead of an index ETF, China should be managed with a long-short equity strategy. Whether that’s actually possible (restrictions from Chinese securities regulators) is an obvious limitation but certainly there’s optimal solution somewhere in between.

Although late in arriving by just over two months, put options on GDX, PBW and PHO are certainly a good arrival for investors in these underlying positions.

Investors who use some sort of risk budgeting system to help in determining asset allocation constraints will be happy to see more options for ETFs that have historically shown large price volatility. The recent discussions on this site on the pros/cons of inverse funds, shorting and put options should allow more investors to essentially manage their portfolios in a very “hedge fund”-like manner.

OK, we’re well into earnings season with not much in terms of surprises. Financials are showing generally good strength, but there’s really not much to focus on. At least earnings should be the focus. Obviously, it really isn’t. So what’s then is the focus?  Geopolitical tensions related to:

1. War: Possible regional war involving Israel, Lebanon, Syria, Iran … there’s some talk out there about this being the start of a world war although that’s quite a big jump … however, think about what started WW1 and WW2, regional wars in certain parts of Europe

2. Oil supply disruption: Nigerian pipelines again

3. North Korea: No one foresees a war there because China (business is good), Japan (too much to lose) and Korea (still growing well) all are too close to eachother to risk going nuclear. NK might not be there in terms of launch capabilities, but who knows if their nukes can be dirty bombs?

4. India bombings: More bad news for emerging markets who really got hurt in the past few months

5. Cold relations between the US and Russia. Bush and Putin seemed to talk nice in the G8 meeting but the trend does not look like they’re getting closer together. It’s in the US’ interest to figure out something … they have to with oil prices at all time highs and Russia pushing its agenda in eastern Europe (as well as its ally in China … think war games exercises held jointly by both armies last year).

6. With all of the above, it’s almost like Iraq isn’t an issue but you can’t say that with casualties still occurring on all sides and US dollars continually being spent there.

And so where are the markets now? About where they were at the market low (June 13/14). Nasdaq is actually quite a bit lower.

I was hoping for markets do drive up to new highs and then drop down to push past the lows of June 14th. It’s happening sooner than I thought. No one could have predicted this since it’s mainly due to the action in Israel/Lebanon. With oil very close to 80 (some talk of 90), can the US economy keep humming along. Numbers from China continue to amaze me. They’re traveling around Africa and other corners of the world buying up expensive oil (among other commodities), but they’re still moving in high gear.

What’s the chain reaction? Inflation numbers up globally. Central banks continue to tighten globally. Liquidity dries up globally. Hunkering down (less spent on travel/leisure, reduced discretionary spending by consumers, business and governments, etc.) leads to slower economy continuing the concerns of slower and possibly even negative growth. Stagflation?

Why did the 10 year blip downwards on various occasions last week while the short side of the curve moved up a bit? The very short end is going to go up if the Fed (in addition to other central banks) continue to raise rates. Inverted curve not discussed as much these days but it could be a sign that agrees with my stagflation argument above.

I saw online that Bill Gross is talking about possible rate cuts by early next year. More fears of negative growth over inflation.

A very confusing time. In confusion, you must do the following:

1. Remember, keep high cash balances to prepare for shopping when prices are really depressed.

2. Watch the VIX (market volatility index). Buy at-the-money VIX calls when VIX is anywhere close to 12.

3. Keep the portfolio diversified. Keep minimal positions in stocks, bonds, cash and alternatives (gold, REITs, hedge funds, etc.). Despite the fact that correlations spike to 1, thus losing its benefit, its still better than putting all your eggs in one basket. If there is a bias to anything, it should be cash, then maybe gold.

4. Stock up on commodities. I stilll like gold. I still like energy. The various geopolitical events causing greater uncertainty works well for these (more the commodity itself than the stocks). However, in the case of both gold and energy, I strongly believe in owning both the commodity (futures if possible) as well as the stocks in that sector (ETFs if possible or direct stock selection).

The equity markets have basically had a straight line up since early 2003 through April 2006. It was time that the markets gave back something. The declines of May/June brought markets back to where they were near the beginning of the year (S&P 500 dropped to prices last seen in early Nov 05). So markets have basically given back six months of gains. But they were big gains (9.0% from Nov/Dec 05 to highs of 2006). I’m not certain if the “give-back” was enough. My view is that markets may retest the highs but won’t go far beyond if they do. My greater concern is for the market to strongly test the lows of mid June before the end of this year. By how much, no one can know.

Some say fundamentals look good now, better than they’ve been in a long while. With all the stimulus on the market now, the time to buy is when fundamentals look even better and there is greater clarity on many subjects, both macroeconomic and geopolitical. It may be too late to sell but investors should hold minimal amounts of all major asset classes anyway, assuming they have long term objectives. Still too early to buy. Now’s the time to accumulate cash where possible.

Watching Tuesday’s launch of the space shuttle live on CNN got me thinking about risk management, since a lot of the commentary was about the threat of foam falling off the shuttle’s exterior, just as had been in the case during the Columbia disaster when the shuttle was destroyed upon re-entry from space.They also discussed other possible mishaps. The comment was made that at one point all the astronauts as well as technicians down on the ground were thinking the same thing: “Hope I didn’t forget something” or “Hope I don’t mess it up.” Though only discussed for a relatively short period of time, it was a rather uncomfortable tone for what was a very nice July 4 day in Cape Canaveral.

So, the question I have is what risk management process did NASA go through after Columbia? NASA is the home of the real “rocket scientist”. I recall from the movie Armageddon, one of the NASA guys trying to figure out how to save the world from a giant meteor’s impact was supposedly “the smartest guy in the world.” Really now? Well, if there’s a book on the subject, I’d be interested in reading it.

Should be good for investors to consider that “black swan event” (term from Nassim Taleb’s book Fooled By Randomness), how best to plan for it, and how to deal with it when it eventually happens.

Just a thought. Are there little things that can happen (consider something as insignificant as a piece of tile falling of the underbelly of the shuttle) that could cause so much trouble that it causes massive damage to an entire entity? That tile is clearly no longer considered insignificant. Of course there are many potential causes for the markets, and thus your portfolio, to have a serious disaster. There are numerous scenarios starting with countless initial events that could cause a cascading effect resulting in a major market meltdown.

Now, we really don’t have to consider a complete “total destruction situation” where a diversified portfolio falls to zero. However, we can all think of scenarios which lead to a 50% loss or more. I’m not sure that the actual number is important. I’m not even sure if the causes are important because, frankly, can we do anything about it? What is important is to remember that in times of complete distress in the markets, correlations spike close to 1. This means that the benefits of diversification fail investors when they’re needed the most. There’s a similarity where distress to a certain component of the shuttle may lead to its total destruction.

So what should be of high importance to investors is what can be done on relatively short notice to cushion the blow of a quick and major market downturn?

First, before trying to trade your way out of trouble, make sure the basics are in place: diversify your portfolio well with various uncorrelated and even negatively correlated positions. Strategic asset allocation is key including the importance at times for high safety positions (cash/gold). Diversification fails, but not often.

When it does fail, not everything fails completely. VIX options and futures are good examples of instruments which are very negatively correlated with general market trends, although truly effective as a short-term play. Broad market equity index derivatives (buying put options, shorting index futures) are a cheap and easy method. But with the recent inverse ETFs, there’s a choice for investors who are accustomed to holding only long positions in funds. These funds have been discussed numerous times before, but here’s the list again:

* Short QQQ ProShares (Amex: PSQ)
* Short S&P 500 ProShares (Amex: SH)
* Short Dow 30 ProShares (Amex: DOG)
* Short MidCap S&P 400 ProShares (Amex: MYY)

In all cases, when you start to consider these as potential positions, you have to switch from your “strategic asset allocation hat” to “tactical asset allocation”. It just doesn’t make sense holding these positions for very long unless you are in a serious decline like in 2000-2002 or those of the early and mid 70’s. On the other hand, all of these potential choices have a cost if you’re wrong about the direction of the market. Clearly that’s what hedging is all about.

You buy insurance for your home, car and body. Assuming you keep up your home, change your car’s oil and are disciplined about daily vitamins and exercise, doesn’t your diversified portfolio require insurance as well?

My argument is that it’s slightly different for a portfolio. I don’t think you need continued exposure to a hedged position (long put, inverse ETF position or otherwise) as you do with daily vitamins. But with TAA, it’s all about the timing. Yeah, it’s tough. But it’s not rocket science.

Let’s get ready to rumble. Non-market cap weighted indexation is starting to heat up even futher. DFA started it a long time ago. Rydex brought out RSP a little over 3 years ago.Rob Arnott has been talking about fundamental indexation for a few years now, and his firm Research Affiliates teamed up with index provider FTSE and manufacturer PowerShares to provide the first “fundamentally based” index ETF with The PowerShares FTSE™ RAFI US 1000 Portfolio (PRF).

With WisdomTree’s version of fundamental indexation based on the research of Professor Jeremy Siegel (focused on dividends, while Arnott’s version is based on four fundamental factors: book value, income, sales and dividends) launched just last month, PowerShares has countered with news of the registration with the SEC for ten new funds. Again they will be branded as PowerShares FTSE™ RAFI Portfolios but will cover nine sectors. One will cover small-mid caps. Here’s the list:

* FTSE RAFI Basic Materials Sector Portfolio
* FTSE RAFI Consumer Goods Sector Portfolio
* FTSE RAFI Consumer Services Sector Portfolio
* FTSE RAFI Energy Sector Portfolio
* FTSE RAFI Financials Sector Portfolio
* FTSE RAFI Health Care Sector Portfolio
* FTSE RAFI Industrials Sector Portfolio
* FTSE RAFI Telecommunications & Technology Sector
* FTSE RAFI US 1500 Small-Mid Portfolio
* FTSE RAFI Utilities Sector Portfolio

It will be very interesting to see the growth in assets in these funds versus those of WisdomTree. One thing that has always been an important truth in the ETF industry is that first to market matters. Consider GLD versus IAU. In this case however, there is more of a fundamental (sorry) difference between what WisdomTree and PowerShares are providing.

Side note: PowerShares is reportedly registering 31 new funds with the SEC, including those mentioned above. The vast majority of these new funds (all but 6) are sector funds. Question: Don’t we already have enough sector based ETFs? If they don’t have comparable MERs or cover new territory (geographic or otherwise), you really have to wonder. The one that really gets my interest is the Cleantech ETF. I’d like to add that to our PBW position.