PowerShares has finally launched the ETFs that take choices for alternative energy beyond PBW in this space.The following 3 funds began trading yesterday on the Amex:

PowerShares Cleantech Portfolio (PZD)

PowerShares Progressive Energy Portfolio (PUW)

PowerShares Listed Private Equity Portfolio (PSP)

I’ve commented on all three of these ETFs in the past here:

A Look at the New Private Equity ETF

PowerShares WilderHill Clean Energy ETF: Leverage Through Volatility

97 New ETFs Planned for U.S. Market — Powershares Leads the Way

For this entry, I will not comment on the private equity fund.

For investors in PBW, the new cleantech fund and the progressive energy fund may be a bit of overkill in terms of holding all three. First let’s review PBW:

PBW peaked at just under 24 in early May ending a 50% rise since the beginning of 2006. Wow. However, like all of the energy complex it fell hard this summer. PBW had a drawdown of roughly 30% hitting lows around 16.30 in late September. In fact, since September 22nd, PBW has risen about 13% to October 16th. A pull back in the past week and a half to just under 18 at the time of writing makes this look like a good point to get in. Recent action can’t be considered evidence of the beginning of a longer term uptrend but we’re still in a much better valuation than we were in early May.

PBW holds a diverse portfolio of 42 stocks with the largest sector weightings in IT (37%) and industrials (29%). Although it holds a small number of relatively “clean” utility companies, I consider this fund as a Nasdaq play on stocks with an alternative investment bent. I see alternative energy as a new technological wave commonly seen in major Nasdaq uptrends. Tech waves in the past have come in different forms but are clearly based on new innovations such as the biotech/pharmaceutical wave and the telecommunications/internet wave. On the positive side for alternative energy, we’re nowhere near the speculative state of the dot com bubble. But with 42 stocks and a small cap growth bias, this fund is significantly more volatile than the Nasdaq which is a volatile index itself! Based on this kind of volatility, PBW shouldn’t comprise any more than 5% of a portfolio.

Taking this argument of a high-tech fund to the extreme leads to the new cleantech fund. This is simply one to watch. Here’s the site for this ETF:

According to the site, “A company is considered to be part of the cleantech industry if it produces any knowledge-based product or service that improves operation, performance, productivity or efficiency, while reducing costs, inputs, energy consumption, waste or pollution.”(emphasis in this quote is mine)

Also from the website, I find that this fund has sector weights very similar to PBW. In the case of PZD, it’s 27% in IT and 43% in industrials. Again, roughly two-thirds of the fund is dominated by these two sectors. Also similarly, both funds have roughly three-quarters in small cap holdings. Although PZD does not hold utilities like PBW (roughly 9% weighting), there is still a significant amount of common holdings between these two ETFs. Refer to the PowerShares site to find the holdings in both to do the usual comparison shopping.

I’m eager to see the initial price action of PZD but my expectation is a slightly more volatile chart compared to PBW.

In the case of PUW, the fund is based on the WilderHill Progressive Energy Index. “The Index is comprised U.S.-listed companies that are significantly involved in transitional energy bridge technologies, with an emphasis on improving the use of fossil fuels. The modified equal-weighted portfolio is rebalanced and reconstituted quarterly.”

Again, I find it interesting to find another ETF moving away from market cap weighted indexation. This continues the trend started with RSP (Rydex S&P Equal Weighted Fund) and furthered today by firms like PowerShares, Claymore and WisdomTree. Although not an ETF manufacturer, I always try not to forget Dimensional Fund Advisors, the pioneer in the space of non-market cap weighted passive funds.

Looking at the stats on this ETF (sector weights, underlying holdings dispersion by market cap, etc.) I find it to be the most unique, or at least significantly different in its composition compared to PBW and PZD. I would guess that this would be the least volatile of the three. Despite this assumption, again I have to state clearly it would still be significantly more volatile then the Nasdaq. Here’s a historical chart picked off the PowerShares site:

I still believe that these funds will have strong correlations with the commodity indices, especially with the strong bias in these for energy. Like energy, these will be volatile so I can’t think of holding any combination of these in a sum of more than 5% in a portfolio. There are also other “alternative energy” parts missing with these three funds. For example, what about exposure to uranium? Considering how many nuclear plants exist today and are either being built or are in the planning stages, perhaps it is no longer an “alternative” energy source. Still, it’s another area I like.

Of all the so called “alternative” asset classes, real estate has to be the most basic of them. I often define “traditional” asset classes as simply stocks, bonds and cash with alternative covering basically everything else.I have written in the past about real estate, mostly with a negative bent. However, in the interest of finding new instruments (preferably of the indexing type) I refer to this article in the Wall Street Journal (sub. required) that mentions State Street Global Advisors and their SEC filing of an ETF “based on real-estate securities in 23 countries”. With all the attention to real estate in the past few years, it’s interesting that all ETF related products have been so focused on the US market (REITs, homebuilders).

According to the WSJ, this new ETF in the works should solve this problem with one position: “The State Street fund will be based on the Dow Jones Wilshire ex-US Real Estate Securities Index. The “ex-US” means there are no U.S. stocks.” Furthermore, there is some concern regarding just how diversified this one position will be: “Investors should note that, despite the large number of countries in the index, nearly 60% of the holdings are concentrated in just three: Australia with 20%, the United Kingdom with 19%, and Japan with 18%. The top nine countries comprise just more than 90% of the weightings.”

The article mentions a mutual fund, the Northern Global Real Estate Index Fund [NGREX], although as a global fund it includes US securities and thus has a slightly different mandate:

This makes me think about what I wrote about new products being released near market tops. However, with a 9% return since inception, I look to be wrong in this case. On the other hand, seeing this chart simply gives me more reason to put this upcoming ETF on a watch list. Not an immediate buy.Kudos to SSGA for getting back into the ETF game with some decent new offerings, but not with just another US equity mid cap growth ETF (or whatever). I spoke recently about new indices related to environmental services and steel from SSGA (perhaps this could lead to ETFs?), and now international real estate. So how about timber and infrastructure? These have been mainstream asset classes in the institutional space for quite some time now.

First there was Rob Arnott and his firm, Research Affiliates, who now manage ETFs with a fundamental indexation strategy for PowerShares and Claymore. Then WisdomTree entered the market with their version of fundamental indexing although based on dividends while Arnott’s was a combination of dividends plus three other fundamental factors. Now comes news of an ETF behemoth entering the market. Here’s the press release from State Street Global Advisors.

Let’s see. Here are the main points that I get out of this press release:

· “FTSE GWA index is one of a new breed of indices that weight stocks based on fundamental financial data rather than their relative size in the market”: FTSE is diversifying its non-market cap weighted indexation business. It already has the FTSE-RAFI indices with Rob Arnott and his group. The new FTSE-GWA indices seem to be direct competition to the FTSE-RAFI and not to WisdomTree’s indices.

· “…historic studies suggest that the strategy can be expected to outperform traditional market capitalisation indices by approximately 2 percent per annum over the long-term with similar or lower levels of risk.”: This sounds a lot like what Research Affiliates says. In fact, in John Mauldin’s book, he has a chapter dedicated to a discussion with Rob and the “2 percent premium”.

· “Wealth-weighted indices, by definition, hold greater weightings in securities with below-average price to earnings (or price-to-book or price-to-cash flow) ratios and are therefore considered “value” biased.”. This is followed up a couple of paragraphs down by this: “the weighting of individual securities is based on fundamental financial data — in this case earnings, cash flow and book value — rather than a security’s price and number of shares (market capitalisation).”: So SSGA focuses on 3 factors: earnings, cash flow and book value as opposed to Research Affiliates and their 4 factors of book value, income, sales and dividends.

· “…expects the product will co-exist peacefully with market cap indices, providing an interesting investment alternative.”: I have agreed with the idea of using very low cost market cap weighted ETFs along with some use of fundamental weighted ETFs.

I’m not sure what to think of this. Barclays Global Investors and SSGA have been the big gorillas in this industry from the beginning. Although having some big names like the Spyders (SPY), SSGA has basically lost the battle in the retail oriented ETF business. However, with its stated US$1.5 trillion mentioned at the bottom of the press release, “losing” hardly seems like the appropriate term. Certainly, like BGI, SSGA has a very substantial institutional business. But diversifying into fundamental indexation? This leads me to believe that Research Affiliates and WisdomTree are still so small that they might just not have the logistics and resources to tap the global megapensions and endowments who would be interested in this new innovation - or at least SSGA sees a window of opportunity as they already have the ear of many in the institutional space (at least more so than Research Affiliates). But that’s the institutional side.

What happens if SSGA decides to build products (ETFs) based on their fundamental indexation methodology for the masses. This could be an unforeseen problem for both Research Affiliates and WisdomTree. In the ETF market, “first to market” matters (think GLD versus IAU), but if SSGA enters the ring, it really would be a case of two Davids versus a supersized Goliath. I still am a supporter of Rob Arnott and his group. Frankly, his 4-factors just makes more sense than the alternatives and the numbers back it up.

[However, to make full disclosure, I have zero of my client’s assets in any form of fundamental indexation products. All our non-market cap weighted exposure is in funds managed by Dimensional Fund Advisors as we’ve been with them since 2003.]

I see no rush for me to add or change positions related to this discussion as I plan to wait and see how this new area develops. This news from SSGA is certainly interesting and if SSGA were to enter this specialized market, I would only see a “lowest cost” approach as a way to entice investors to consider their offering.

We’ve seen the S&P 500 go up in a strong linear fashion since mid July. A bit extended perhaps? Here’s the 3 month chart:

  We’ve seen some fairly low values in VIX over the past few months as Here’s the 2 month chart for the VIX:

  Incredible to see a few days under $11. It’s been down at $11 before (even as low as $10) as seen in this 3-year chart:

  What’s interesting is the behavior of the S&P 500 relative to the VIX. Here is a chart showing the two:

  An obvious pattern shown clearly in the chart above is that the S&P 500 is climbing well when VIX is falling. This is usually over a 2-3 month period:

· May-June 2004

· mid August-early October 2004

· late October-Christmas 2004

· mid April-late July 2005

· mid October-Christmas 2005

· July-current 2006

If the current trend (upward S&P 500 and downward VIX) continues, then this would be a significantly larger and longer decline period of the VIX (going into 4 months). We’re currently just past the 3 month mark.

Looking at the 3rd chart above, $10 seems to be a fairly firm floor, although it seems like VIX doesn’t like staying down there. There’s almost a propensity for the VIX to bounce off $10-$11 and within a month reach $14-$15.

Bottom line: This looks like a good time to buy VIX call options. If the S&P futures look weak Wednesday morning, a quick entry may be in order … I started off this piece with the question if this rally may be a bit extended. Patient watchers may want to “wait and see” in the hopes of entering when VIX is closer to $11.

I received the latest press release form Van Eck Global. Earlier this year, they entered into the ETF market with their first offering – a gold producer ETF (ticker: GDX). As of September 30, 2006 it has over $250 million in assets and averages over 500,000 shares traded per day. It’s even option eligible. We maintain gold exposure through XGD, an iShare ETF domiciled in Canada giving exposure to stocks in the TSX Gold Subindex. Basically, this would be Canada’s counterpart to GDX. This is complemented with GLD. We’re holding no more than 5% in these gold related positions right now and don’t plan on touching these.Some news on two new ETFs from Van Eck Global from today’s press release:

Today, we are launching two new unique ETFs, one on Environmental Services and another on Steel shares. Both are based on indices developed and calculated by the American Stock Exchange.

Market Vectors Environmental Services ETF (ticker: EVX) is the only way we know of for investors to gain exposure through an ETF or mutual fund to the fast-growing environmental services industry. This ETF seeks to track, before fees and expenses, the performance and yield of the Amex Environmental Services Index [AXENV].

Market Vectors Steel ETF (ticker: SLX) gives investors a unique and important way to focus on steel, an industry that is fundamental to consumer durables, capital spending and construction and one undergoing significant change. SLX is the only ETF or mutual fund that we know of that investors can use to gain exposure to the steel industry. This ETF seeks to track, before fees and expenses, the performance and yield of the Amex Steel Index [STEEL].

More information on Van Eck and their “Market Vector” family of ETFs can be found at on their website.

With regard to EVX, I think about how it might play along with our clients’ positions in PBW (PowerShares WilderHill Alternative Energy ETF) which I have discussed in the past here and here. PBW casts a fairly wide net. It has utility companies that are relatively clean in terms of using hydroelectric power versus the burning of fossil fuels as one example. It also has significant “high tech” type exposure with companies in the clean energy industry. In fact, according to the PowerShares website, IT has the largest sector weight in PBW with 37.26%. For anyone interested in doing some “comparison shopping”, here’s the list of constituents in the Amex Environmental Services Index [AXENV) picked right off the AMEX website:

Amex Environmental Services Index [AXENV]

“Constituents as of September 29, 2006″

Ticker Component Name Shares

(ARS) Aleris International Inc. ” 112,920 ”

(AW) Allied Waste Industries Inc. ” 523,358 ”

(CCC) Calgon Carbon Corp. ” 801,254 ”

(CLHB) Clean Harbors Inc. ” 133,699 ”

(CVA) Covanta Holding Corp. ” 271,936 ”

(CWST) Casella Waste Systems Inc. ” 312,291 ”

(DAR) Darling International Inc. ” 1,411,638 ”

(ECOL) American Ecology Corp. ” 298,630 ”

(FTEK) Fuel-Tech N.V. ” 237,863 ”

(LAYN) Layne Christensen Co. ” 196,169 ”

(MTLM) Metal Management Inc. ” 212,749 ”

(NLC) Nalco Holding Co. ” 304,219 ”

(NR) Newpark Resources Inc. ” 1,069,342 ”

(RSG) Republic Services Inc. ” 433,275 ”

(RTK) Rentech Inc. ” 1,205,275 ”

(SGR) Shaw Group Inc. ” 234,497 ”

(SRCL) Stericycle Inc. ” 83,439 ”

(SYGR) Synagro Technologies Inc. ” 842,800 ”

(SZE) SUEZ France ” 383,091 ”

(TTEK) Tetra Tech Inc. ” 330,558 ”

(VE) Veolia Environnement ” 286,354 ”

(WCN) Waste Connections Inc. ” 149,905 ”

(WMI) Waste Management Inc. ” 475,926 ”

(WSII) Waste Services Inc. ” 370,612 “

Just below this list on the same page, AMEX gives daily price data going back to March 30, 2001 for all you backtesters.

For those of you more interested in the Steel ETF, here’s the low down on the Amex Steel Index (STEEL) from the same source:

Amex Steel Index [STEEL]

“Constituents as of September 29, 2006″

Ticker Component Name Shares

(AKS) AK Steel Holding Corp. ” 176,054,206 ”

(ATI) Allegheny Technologies Inc. ” 161,006,988 ”

(CAS) A.M. Castle & Co. ” 26,503,386 ”

(CGA) Corus Group PLC ” 797,929,419 ”

(CHAP) Chaparral Steel Co. ” 74,220,357 ”

(CLF) Cleveland-Cliffs Inc. ” 67,012,665 ”

(CMC) Commercial Metals Co. ” 193,332,833 ”

(CRS) Carpenter Technology Corp. ” 40,811,599 ”

(FSTR) L.B. Foster Co. ” 16,795,555 ”

(GGB) Gerdau S.A. ” 690,673,048 ”

(GNA) Gerdau AmeriSteel Corp. ” 488,139,610 ”

(IPS) IPSCO Inc. ” 75,477,624 ”

(LSS) Lone Star Technologies Inc. ” 49,212,576 ”

(MSB) Mesabi Trust ” 20,986,446 ”

(MT) Mittal Steel Co. N.V. ” 580,505,687 ”

(MTL) Mechel AOA ” 221,952,459 ”

(MTLM) Metal Management Inc. ” 43,028,612 ”

(NSS) NS Group Inc. ” 36,217,615 ”

(NUE) NuCor Corp. ” 258,252,205 ”

(NX) Quanex Corp. ” 59,128,351 ”

(OS) Oregon Steel Mills Inc. ” 57,282,440 ”

(PKX) POSCO ” 264,141,742 ”

(RIO) Companhia Vale do Rio Doce ” 1,905,989,847 ”

(ROCK) Gibraltar Industries Inc. ” 47,643,391 ”

(RS) Reliance Steel & Aluminum Co. ” 120,668,864 ”

(RTP) Rio Tinto PLC ” 213,201,208 ”

(RYI) Ryerson Inc. ” 42,017,680 ”

(SCHN) Schnitzer Steel Industries Inc. ” 49,162,989 ”

(SID) Companhia Siderurgica Nacional ” 416,449,219 ”

(SIM) Grupo Simec S.A. de C.V. ” 224,588,561 ”

(STLD) Steel Dynamics Inc. ” 80,868,198 ”

(STTX) Steel Technologies Inc. ” 20,871,276 ”

(TKR) Timken Co. ” 150,337,812 ”

(TX) TERNIUM S.A. ” 320,673,531 ”

(USAP) Universal Stainless & Alloy Products Inc. ” 10,298,075 ”

(WOR) Worthington Industries Inc. ” 141,868,054 ”

(WPSC) Wheeling-Pittsburgh Corp. ” 23,529,773 ”

(X) United States Steel Corp. ” 199,724,908 ”

(ZEUS) Olympic Steel Inc. ” 16,680,385 “

I see the Steel ETF as a potential building block for an infrastructure sub-portfolio. Thus far, I have focused on closed end funds from Macquarie (MIC, MFD, MGU, etc.) all traded on the NYSE. Stock selection makes sense here as well with positions such as CEMEX (CX) and Caterpillar (CAT). It’s amazing how this commodity plays into so many other asset classes. Another case aside from infrastructure would be alternative energy. I’ve heard from wind farm developers that one of their biggest costs is the price of steel. Another correlation play tying the commodity complex with alternative energy.

If you’re looking for the link that leads you to the above data, here it is.

Some further interesting notes about the composition of the two underlying indices from AMEX. This is from an October 3rd press release from AMEX found on PRNewsire:

The Amex Steel Index is a modified market capitalization-weighted index comprised of publicly traded companies involved primarily in the production of steel products or mining and processing of iron ore. The Amex Environmental Services Index is a modified equal-dollar-weighted index comprised of publicly traded companies that are engaged primarily in consumer waste disposal, removal and storage of industrial by-products and the management of associated resources.

If you read closely you’ll see that the Steel Index is market cap weighted. The Environmental Services index is equal dollar weighted. I would very much be interested to hear what Rob Arnott would have to say about this. He’s the first person I heard discussing the benefits of non-market cap weighted exposure with first the concept of equal weighting and then the concept of fundamental indexation.

From the same press release, the next paragraph states:

The Amex Steel Index includes common stocks or American Depositary Receipts (ADRs) of selected companies with market capitalizations greater than $100 million that have an average daily volume of at least $1 million over the past three months. The Amex Environmental Services Index includes common stocks or ADRs of selected companies with market capitalizations greater than $100 million, three-month trading price greater than $3.00, and three-month daily average traded value greater than $1 million.

It’s fairly clear that there are not a lot of steel companies that can be put into the Amex Steel Index. However, the environmental services is certainly an area for decent long term growth. I would expect to see hundreds if not thousands of potential stocks that could be in this index now and in the not too distant future. Keeping a $3.00 minimum average price makes sense if not simply to keep the cost of running this ETF reasonable.

I love these new ETFs breaking into new asset classes. Keep ‘em coming.

This is really a follow up to Roger Nusbaum’s piece on the oil sands ETF. I mentioned this ETF, albeit briefly, here. I know: home field advantage as the Claymore guys here in Toronto are only a 5 minute drive away from my office.By the way, the weighting of underlying positions in this ETF is based on three factors:

1. Current production in barrels per day

2. Production expected in 2015

3. % of total production actually in Canadian oil sands

When I first heard of Claymore and the oil sands ETF, I thought they would have launched it by mid-late summer. I just spoke with the prez of Claymore Investments and he says this fund should be out by the end of October or first week of November. Oh that’s some good timing.

But here’s the point, or rather question, in this blog entry:

Personally, I still like oil and have not dumped our energy ETF positions although for private client accounts they are somewhere at around 4-8% of the overall portfolio. However, although I like oil, I’m not so sure about natural gas.

To me, one is a global commodity play that has some geopolitics as well as obvious emerging market stimulus. The other is a regional weather play. I won’t get into El Nino or the supply/demand imbalance for natural gas.

Bottom line: Long oil and short natural gas may be in play for roughly six months. Futures is easiest to implement, but I wonder is there a way to play natural gas in the ETF or CEF space?

Aside: I often write more on SeekingAlpha ETF topics rather than energy, so my apologies if this oil/gas discussion is a replay.

I’m just going get this out of the way and say it: There’s no alpha in ETFs.

That may be a given for many, but with all the new products being launched based on some sort of active management (including some rather “black box” mystique within the ETF space), I thought a discussion of the concept and perhaps definition of alpha was required. Furthermore, as a market participant very much interested in the management of betas (different market exposures), this topic is really about what I do. Consider that some disclosure on my bias in this matter.So you can go from market cap weighted indexation to fundamental weighted indexation. You can call a product an Intellidex or Alphadex or some other term that seems to meld the idea of active management implemented within some form of index fund or ETF. But I can’t get around the fact that it’s just not alpha.

If what is being proposed is a US large cap equity strategy (or whatever) based on some set of rules that, in the long term, beats the S&P 500 Index (or the relevant benchmark index), that may be deemed as alpha. It certainly could be evidence of a strategy that over a certain period of time beats a market cap weighted index. This is “alpha” in a statistical context based on portfolio theory such as CAPM. [As an aside, there was considerable debate about the merits of CAPM but generally most market participants now agree that the flaws (due to generalizations and required assumptions) of CAPM make it simply good theory but weak on application. Do a Google search for “CAPM is dead” to find out more on this discussion.]

Thus far I’ve discussed what can be defined as statistical alpha. But is it really alpha?

To me alpha is a very rare thing. Stepping away from a mathematical definition, I look at alpha as returns that can not easily be duplicated. It would be a rare finding in which a market participant can truly exploit an inefficiency in the market. I would agree with the observation that there’s less alpha now than in the past. There’s certainly more market participants out there trying to uncover every stone to find their elusive alpha. There are more hedge funds whose purpose is to provide alpha … we would hope it’s “pure alpha” if they specifically aim to perform strongly in both good and bad markets. Perhaps there’s no change in the amount of alpha out there, but because of so many participants, especially hedge funds, there’s simply less to go around “per capita”.

What I’m getting at is that there are really two definitions of alpha. One is the statistical definition. If a manager or investor can beat their benchmark index by X% on average every period, that’s their “statistical” alpha. So for every XYZ Capital Management out there who has shown that kind of result, they can calculate their alpha or outperformance over the index.

However, the other definition of alpha that I am trying to focus on here is that which relies more on a qualitative rather than quantitative due diligence on a manager or instrument including certain ETFs that are loosely classified as “quasi-indexing” which I list below. By the way, I’m not sure what the right term for these is, but I don’t see anything wrong with quasi-indexing.

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.

Yikes. Does this mean that hedge funds and the search for alpha are synonymous to money down the drain? No, I would say this is like any analysis of market efficiency. It’s definitely not black and white. The US market is highly efficient with thousands of participants providing tons of analysis and many more putting their money where their mouth is. You have less analysis and less market participation in certain developing markets (in addition to other factors like government regulation) which creates a less efficient market environment. So in the US, there’s a far greater argument to use ETFs than for any given emerging market exposure. At some point in time, with greater “commoditization” you move from a market that looks more like India (for example) to one that looks more like the US. This would seem to agree with points 1 and 2 above.

Similarly, with hedge funds, there simply has to be some evolving where one form of alpha has to be replaced with another. Hedge funds (and especially “fund of funds”) and multi-strategy funds are in the business of finding the next alpha. Whether this is something that can be done successfully and on a repetitive basis is a very good question. Like anything else, the market will decide.

But this leads to point #3 above. As alpha is exploited, it will be commoditized and become some alternative form of beta. In my opinion, this is the real key point of this paper. Alpha will eventually become beta. If it’s a good idea, a set of rules can be force fed into a computer model that can run it on autopilot. (I will admit that not every strategy can be transformed into a quantitative model and thank goodness because there’s got to be some active management left for the industry! Many pros rely on performance fees. This makes me wonder … performance fees are a good reward for true alpha. Should quasi-index ETFs charge performance fees if they truly provide alpha?)

Strategies on autopilot. Is this not what these ETFs listed below are all about? All of these ETF’s have in some way turned a systemic market “inefficiency” into a commodity:

PowerShares Dynamic Market Portfolio (PWC), PowerShares Dynamic OTC Portfolio (PWO) and the various other Intellidex based ETFs from PowerShares

The various FTSE/RAFI ETFs from PowerShares and Claymore

WisdomTree ETFs

First Trust DB Strategic Value Fund (FDV)

I am not negative on ETFs such as these which I would broadly classify as quasi-index ETFs. I simply don’t think that they provide alpha. They provide what may loosely be considered as alternative forms of beta or broad market exposure. Traditional ETFs have been based on traditional market cap weighted indexation. These new (some not so new) offerings provide a change, and in this case I think change is good because we are getting new forms of broad market exposure. However, some clearly, or at least in my opinion, provide better value to the investor than others. That’s another discussion.

An ASEAN ETF will soon be trading on the Singapore exchange … we can only hope a similar version will be made available in North America. This may be possible as Barclays Global Investors is the underlying investment advisor for the ETF. The sponsor is a Malaysian based financial services group called CIMB. The FTSE/ASEAN ETF will track the FTSE/ASEAN 40 Index that holds the top 40 stocks weighted by market cap and free float adjusted in Singapore, Indonesia, Malaysia, the Philippines and Thailand. No idea yet about the allocation among the five markets but I hope it’s not too heavy in Malaysia since it already has its own ETF (EWM).The Association of Southeast Asian Nations [ASEAN] is a political and economic organization of countries founded by the five nations included in the index. We hear of this group every year when they have their annual meeting but market watchers have made numerous comments recently regarding the ASEAN markets’ recent success: up roughly 110% over the past five years.

In the ETF emerging market space, there really isn’t that much choice in terms of broad regional exposure. iShares Emerging Markets Index (EEM) and Vanguard Emerging Markets ETF (VWO) have the shotgun approach, and iShares S&P Latin America 40 Index (ILF) provides Latin American exposure. That’s about it although of course you have direct country exposure such as iShares FTSE/Xinhua China 25 Index (FXI) for China and iShares MSCI Brazil Index (EWZ) for Brazil. For other EM regions like central/eastern Europe or the Mideast, North American domiciled ETFs just don’t exist so investors are left to find closed end funds or other means.

Each one of the emerging market trading regions (Latin America, C/E Europe, the Mideast, and emerging Asia) should have their own ETF. Perhaps not so much of an argument for a Mideast ETF. For me, EEM is very broad in scope yet has always been heavy in certain names like Samsung Electronics which has been the heaviest holding at roughly 6% for quite some time.

Some strategic asset allocation shifts among various emerging market regions may be required should the US economy slow down in a significant way. Each of these regions has different trading patterns and trends with the US, among other developed and EM regions and also within markets in its own region. Trying to manage this through the existing list of ETFs available (EEM, ILF and various country specific funds) can be onerous. Managing an emerging market sub-portfolio of just three positions (east and southeast Asia, central/eastern Europe, Latin America) through ETFs or CEFs would be my ideal method for now.