I am going to take a short break from posting here on my blog. Not sure for how long but as you’ve likely seen lately, I haven’t been posting that often anyway (less than ten entries per calendar month). It could be a few weeks, could be longer or shorter, we’ll see. Until then, I leave you with the underlying positions and percentage breakdowns in the new offerings from Claymore Investments here in Canada for their two new offerings:

Claymore Global Balanced Income ETF

Claymore CDN Dividend and Income Achievers ETF (CDZ) 27.07%

iShares CDN Dow Jones Canada Select Dividend Index Fund (XDV) 12.93%

Claymore Canadian Fundamental Index (CRQ) 3.75%

Claymore Oil Sands ETF (CLO) 1.25%

Claymore US Fundamental ETF - C$ Hedged (CLU) 2.50%

iShares CDN S&P/TSX Capped REIT Index Fund (XRE) 10.00%

Claymore International Fundamental Index ETF (CIE) 0.96%

Claymore Japan Fundamental Index ETF - C$ Hedged (CJP) 0.83%

Claymore BRIC ETF (CBQ) 0.71%

iShares CDN Scotia Capital All Corporate Bond Index Fund (XGB) 5.04%

iShares CDN Scotia Capital All Government Bond Index Fund (XCB) 4.96%

Claymore S&P/TSX CDN Preferred Share ETF (CPD) 10.00%

iShares CDN Scotia Capital Short Term Bond Index Fund (XSB) 20.00%

Claymore Global Balanced Growth ETF

Claymore CDN Dividend and Income Achievers ETF (CDZ) 4.70%

iShares CDN Dow Jones Canada Select Dividend Index Fund (XDV) 2.80%

Claymore Canadian Fundamental Index (CRQ) 11.03%

Claymore Oil Sands ETF (CLO) 3.97%

Claymore US Fundamental ETF - C$ Hedged (CLU) 20.00%

iShares CDN S&P/TSX Capped REIT Index Fund (XRE) 10.00%

Claymore International Fundamental Index ETF (CIE) 8.71%

Claymore Japan Fundamental Index ETF - C$ Hedged (CJP) 7.49%

Claymore BRIC ETF (CBQ) 3.80%

iShares CDN Scotia Capital All Corporate Bond Index Fund (XCB) 5.11%

iShares CDN Scotia Capital All Government Bond Index Fund (XGB) 4.89%

Claymore S&P/TSX CDN Preferred Share ETF (CPD) 10.00%

iShares CDN Scotia Capital Short Term Bond Index Fund (XSB) 7.50%

More information from Claymore on these two funds can be found in this guide.

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

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

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

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

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

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

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

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

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

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

Today, I had a last minute invitation to speak on Canada’s Business News Network … that’s not a description, that’s its actual name. The channel was formerly known as “Report on Business Television” so you’ll have to decide if their name change was an improvement or not. The six and a half minute clip will be available for viewing online here until sometime late Monday evening of next week (when you click on this link I’ve provided, a small window with a built-in media player should pop open). If this doesn’t work, then go here and scroll down to the 4:40pm “After Hours” program. Hopefully, I will be able to have the clip viewed directly here on this blog at some point.

The opening shot of me appears to be my poker face or I’m about to enter the octagon for combat or it’s the once-a-month event when I screw up WordPress and lose a big chunk of my blog posting. Either way, it’s my “death stare” and I can only imagine that I felt pretty lousy running from my car to the building entrance of the studio in what has to be Toronto’s heaviest rain storm so far this year.

Anyway, the discussion was on market volatility but unfortunately the focus was almost entirely on VIX. I say “unfortunately” only because VIX can be (well, it is) a dry subject due to its rather technical nature. Despite being on the channel several times before, you’ll note that the topic of VIX was not quite enough to get me really loosened up until just a tiny bit near the end.

Well, here are two charts which I discuss during the interview:

3 Year VIX Chart

17.5 Year VIX Chart

I was hoping to get into a discussion on emerging markets, gold and oil markets, and a broader geopolitical debate. But at the end of the day, VIX is a tool worth considering for the defensively oriented investor so there’s merit in its discussion. Along with outright shorting and inverse ETFs, there’s not much out there in terms of true diversifiers/stabilizers available in this high correlation world.

On the other hand, I have actually noticed lately that a lot of hedge funds (fund-of-funds, multi-strategy funds and even some single strategy funds) have had better than decent performance in 2007 YTD. Could it be a result of the VIX spike up since late February? I’m sure it’s more than that but this good performance comes after a fairly long period of so-so returns.

On a separate note, after my interview, I had dinner with one of the ProShares directors who was up here in conjunction with Horizon BetaPro’s launch of their new Canadian energy sector index levered and inverse ETFs. This follows up BetaPro’s launch last week of similar long and short exposure ETFs for the Canadian financial sector.

Based on this BetaPro press release from April, it’s safe to say that we’ll be seeing the gold sector ETFs sometime soon as well.

For review, this is BetaPro’s lineup as of today:

Horizons BetaPro S&P/TSX 60 Bull Plus ETF - HXU
Horizons BetaPro S&P/TSX 60 Bear Plus ETF - HXD
Horizons BetaPro S&P/TSX Capped Financials Bull Plus ETF - HFU
Horizons BetaPro S&P/TSX Capped Financials Bear Plus ETF - HFD
Horizons BetaPro S&P/TSX Capped Energy Bull Plus ETF - HEU
Horizons BetaPro S&P/TSX Capped Energy Bear Plus ETF - HED

The Canadian ETF marketplace has basically doubled in a very short time especially due to the recent product development efforts at both BetaPro and Claymore. Unlike in the US, we don’t have as robust - some may say saturated - ETF marketplace here in Canada. Frankly, we don’t have the broad acceptance of ETFs here like there exists in the US so there is some balance there. I would guess by looking at reports, such as those from Deb Fuhr at Morgan Stanley, that all other markets outside of the US also have a rather small but growing ETF industry and that is likely where we’ll see significant growth as the ProShares, PowerShares, WisdomTree and other smaller participants do the same as BGI, SSGA and Vanguard with their already established global expansions.

I won’t get into the discussions I had with the gentleman from ProShares except for the fact that I asked the question that I think many want to have answered: When do we get the international exposures?

I’ll just leave you with a “let’s wait and see”. Let me be blunt as usual … I’d kind of like to see them, specifically inverse exposures for EAFE and emerging markets available before the end of the summer. Certainly before the end of the year.

Oh, and one last thing to consider for those of you who want to get some inverse exposure to emerging markets. I don’t know if that’s the right call (bearish on emerging markets) but considering the strong run up in China, central/eastern Europe and basically all subgroups in the developing world, it’s worth making preparations. But what to do when there’s no inverse ETF and shorting EEM or VWO is the only reasonable alternative? I suggested to my dinner partner from ProShares that the BetaPro S&P/TSX 60 Bear Plus Fund might be a good choice especially considering the relatively high correlation between the Canadian equity market (TSX 60) and a broad emerging market ETF like EEM. I would only guess that the new inverse energy sector ETF from BetaPro would be an even better proxy for a short EEM strategy. There’s not enough historical ETF data but your friendly neighborhood Bloomberg terminal, Thomson Datastream or similar data source should provide you with data for the underlying index as the evidence you need.

It’s a tough, high correlation world. But perhaps there are ways like this to use high correlations to your advantage. The problem is correlations change in time. I’d much rather have the inverse ETF.

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.

David Hoffman at InvestmentNews.com has the scoop on the news of Rydex being up for sale. He has one story that mentions multiple suitors and then a quick follow up story that specifically mentions again Invesco but also mentions E*Trade Financial.

Invesco makes sense to me as they’ve already started down the path of acquisitions in the beta space with their purchase of PowerShares in 2006. One of the articles mentions that there’s some overlap between Rydex and PowerShares so this acquisition would be a bad move for Invesco. I don’t think so. Rydex focuses on levered and inverse exposures similar to ProShares, not PowerShares which is going after the niche sector ETF market as well as quasi-active strategy ETFs.

Rydex has yet to do what ProFunds has done by creating an ETF-centric organization (ProShares) to go along with its open-ended fund business. Why has Rydex been slow to follow? We know of filings with the SEC as I and many others have discussed the long list of ETFs that are in the pipeline from Rydex. PowerShares has had a fantastic track record of pushing products through the pipeline with very little friction. Maybe the people at Rydex will gain something on that end should this acquisition take place. Another good reason.

Furthermore, I wonder if scale will help both the PowerShares and Rydex families bring fees down. That could help in the Rydex battle against ProShares. PowerShares has multiple competitors in WisdomTree (for its fundamental weighted index ETFs) as well as Claymore and First Trust who both also have interesting niche sector funds as well as quasi-active strategy ETFs. A future pricing war between these firms would signify to me an important evolution in the industry. Saturation would also become a concern in my opinion but I have a feeling that we’re still pretty far away from that, believe it or not.

The tone of David’s last article seems to suggest that the purchase is basically a done deal. I don’t think it’s significant news in the bigger picture but I wonder what the next steps are? Who’s looking to scoop up Claymore or First Trust or Van Eck? There aren’t that many of these lower tier firms to choose from. When I say lower, I mean by assets compared to BGI, SSGA and Vanguard. But there will likely soon be many more new entrants in the ETF provider space. These new entrants will surely bring new ideas to the ETF marketplace as most of the traditional space (broad asset classes, sector exposures, levered/inverse) has been covered. We’ll likely see more target date programs and other “funds of ETFs”. Also expect to see more in the alternative investment space including more in private equity as well as hedge funds. With so much coverage of highs in the S&P 500 and other benchmarks, perhaps the timing of these alternative investments will be right.

Final thought: What if State Street Global Advisors got into the acquisition game? According to this story also from InvestmentNews, SSGA has revised its compensation formula for wholesalers in an effort to focus more on ETF sales efforts instead of mutual funds and SMAs. I don’t think BGI’s shaking over this. There’s a comment in the story about recent strong numbers due to new offerings like their new international real estate ETF. I’m thinking that you put some interesting products in front of the wholesalers and they’ll be quicker in pushing them out the door. Until recently, SSGA wholesalers must have been feeling like domestic auto dealers. Dealer management can somehow try to pay a bit more to sell whatever’s on the lot but if they’re driving an import or have one on their screensaver, you know it’s a losing battle. Maybe SSGA will continue their recent roll of introducing interesting new products (and it’s been good) so it would be unnecessary to even considering purchases. But it makes much more sense than BGI or Vanguard who I don’t see acquiring any of these smaller names at any point in the future.

An article titled “ETFs Enter Transition” (free subscription required) written recently by Julie Henderson at IPE International Publishers describes how institutions are now using ETFs for cash management purposes. Actually, if you’re familiar with BGI and SSGA’s institutional business, transition management is part of the service lineup so the connection between transition management and ETFs is no surprise.

Transition management is important for any investor. Here are a few situations every investor must consider:

1. You have decided to pull your money from a manager and have not decided on the selection of a replacement manager. However, you want to keep your exposure to that asset class.
2. You are an investment counselor for a private client and they are transferring their account to you either a) all in cash, b) securities “in kind” or c) a combination of the two.

3. You are a fund manager and get a large inflow of new monies that should be invested to keep the portfolio exposed to its existing proper proportions.

4. You are a “do it yourself” investor and make periodic investments into your account and are looking for the appropriate process to implement a globally diversified portfolio in a cost-effective manner.

These are just a few examples, but I’ll take them in sequence.

The Manager Replacement Strategy

In this example, I am referring to an active manager in a relative return environment such as a mutual fund rather than a hedge fund. This manager usually has some area of expertise whether it be a region, style (growth or value), or sector specialty. Let’s say that you’ve decided to exit your position with an actively managed fund providing exposure to large cap Latin American equities. Assuming that your asset allocation strategy remains unchanged and you still like the region, but only have a problem with the manager, you could implement a position in ILF or even a combination of country specific ETFs in the region as an interim replacement until you decide (if at all) to replace this with another active manager.

New Client Transition

Here, I’ll take a common example of an advisor with a new client who is transferring their portfolio over from another advisor. If it’s coming over all in cash, then the transition into an all stock portfolio could involve an interim step of implementing purchases of ETFs to gain the broad exposures required immediately. Thereafter, stock specific purchases can be made based on the portfolio manager’s required entry points. For an incoming portfolio that is not all cash, the portfolio manager will have to make the decision whether to sell the stock positions outright or transition into matching ETFs (to keep the existing exposures as it may not be an appropriate time to exit from them). In this case, the transition could be (at its most complex) as follows: stock portfolio -> ETF portfolio -> cash (or directly to) -> ETF portfolio -> stock portfolio.

Fund Manager with New Monies

Imagine you’re a fund manager (mutual fund or hedge fund) and you’re either just starting out fresh with cash or are established but have just received a giant inflow of cash. It may not be logistically possible to simply implement the total cash position into a portfolio of stocks and/or bonds due to size constraints. Of course, the manager could and usually does implement purchases bit by bit through multiple brokers to lessen the market impact. However, the use of ETFs also helps in this situation. Then, in time as the overall fund increases in size, ETF holdings can be peared down in a systematic matter with offsetting stock/bond purchases to keep the proportion in cash in check.

The Do-It-Yourself Investor

For many individual investors, like in the above scenarios, ETFs are more of an interim tool than a long-term hold. Many smaller investors can start out by making regular deposits into their trading accounts as a disciplined means to save. To control costs, this monthly (for example) deposit could be invested in a no load index mutual fund. Then, in time either periodically or during a significant market dip, the investor can move these over to comparable ETFs. The next step, if required, would be to implement a stock or bond specific strategy to fine tune the portfolio.

At the end, you can see that this is all about cash management and the quick equitization of cash to avoid “cash drag”. I’m surprised that the quoted article says that institutions like pension funds are just getting into the use of ETFs for transition management now. Perhaps it’s just that they have relied on outside consultants/managers to handle this process for them, but like with the empowering of individual investors, ETFs (and the broad array of them) have allowed for yet another group of investors to have yet another use of these instruments for the overall benefit of their portfolio.

My point here is that even if you don’t believe in ETFs as a long-term hold within your portfolio but would rather make stock specific calls, there are everyday situations where ETFs are actually quite useful.

One last strategy to consider is based on the cloudy space between strategic asset allocation and tactical asset allocation. SAA is your relatively longer term asset mix decision which can now easily be implemented entirely with ETFs if desired. TAA decisions are more shorter term in nature. However, what happens when you determine that it’s time to rebalance your portfolio? This could be based on a passage of time (such as an annual rebalancing) or based on deviations of your asset mix from your pre-determined SAA framework. Let’s say for example that you’ve had big gains in your equity portfolio and they’re considerably overweighted in your overall portfolio. If you leave it as is, then technically you’ve made a tactical decision to overweight equities. Selling the appropriate amount and moving the proceeds to the currently underweight position(s) would remove the tactical decision and be faithful to the strategic model.

However, doing nothing might be the preferred path for any number of reasons, tax consequences being one, even though tactical measures are desired. In such cases, the existing portfolio holdings could be left intact and tactical positions established using levered ETFs (long or short) or derivatives. This is an area that many large pension plans and endowments are now putting significant resources into in terms of research and manpower. Strategic asset allocation, and models to govern this decision have been around since the beginning of these funds as it’s the foundation of their investment process. However, in many cases, the tactical decision is being internalized as institutions continue to assert themselves as deliverers of alpha yet in a cost conscious manner. These tactical decisions could be, and I believe should be, implemented with the big broad ETFs like SPY or EFA, not necessarily the newer niche ETFs. Trading all of these new ETFs opportunistically I think causes too much of a burden to the vast majority of investors. Holding a position in international real estate or alternative energy shouldn’t be for less than a year or even two in my opinion.

I’ve always thought that the niche sector ETFs and regional exposure ETFs were meant to provide added diversification to the core portfolio. The question is to what degree? A common theme I have often discussed in the past is the increasing correlations among nearly all asset classes as capital markets around the world become intertwined along with their economies. The easy flow of money and information is like fuel to a fire. Even Ray Dalio of Bridgewater Associates, one of the largest hedge fund managers concedes that hedge fund returns have seen greater correlations in time with broad equity indices. If this is truly the case (again, I’ve mentioned this phenomenon several times in past postings), then what’s left for investors in terms of uncorrelated investments to protect them when sh&t happens? Cash and a small handful of other reasonable choices, I suppose.

This is an excerpt from an article in the New York Times:

According to Mr. Dalio’s analysis, over the last 24 months, hedge funds were 60 percent correlated to the Standard & Poor’s 500-stock index, 67 percent correlated to the Morgan Stanley Capital International EAFE (for Europe, Australia and the Far East) index of foreign shares, and 87 percent correlated to emerging market equities (unhedged). They were 41 percent correlated to the Goldman Sachs Commodity Index, 52 percent correlated to high-yield, or junk, bonds, and 42 percent correlated to mortgage-backed securities.

The first caveat is that there are so many possible data sets which could represent hedge funds and anyone can find the appropriate data set that will lead to their pre-determined conclusion. Nevertheless, the 60% correlation with the S&P 500 is higher than many would believe. The other values given are higher. If your hedge fund was marketed as being market neutral and “performing well in both good and bad markets” it should not have correlations similar to what has been provided here by Dalio. But the numbers get worse for some particular hedge fund strategies:

The letter also parsed the correlations by strategy, which is a more precise way to think about hedge funds, since different types of funds take different kinds of risks. Short-biased hedge funds have a negative 70 percent correlation to the S.& P. index, while equity long-short, the description applied to what most people think of as a hedge fund strategy (betting that some stocks might go up and others might fall, usually with leverage) had a huge correlation of 84 percent.

This is actually not new information. Long-short strategies have not only had high correlations especially with the S&P 500 for quite a while (84% is incredibly high) but there’s also the added volatility they bring. VIX overlays are often required. I’m actually happy about these developments because I’ve built a business and expertise in “beta filtering” to deal with this problem which is a serious concern to the institutional investment community.

What’s key is the fact that over a decade ago, the correlation figures were lower:

Then Mr. Dalio looked at data back to 1994, which showed that historical correlations were in the range of 49 to 54 percent; high, but not as high. So as equity markets have done well, hedge funds have done well — not necessarily because of their genius but because they have the wind of the stock markets at their back and because a lot of them use leverage to magnify their bets.

Clearly, beta filtering was not required until roughly the past five years. It’s hard to get data back from the 1970’s and 1980’s since hedge funds were truly secretive and rare beasts at that time. However, it’s fair to assume that with fewer hedge fund participants, among other factors, correlations of their returns with benchmark indices were likely far lower than what we find today. A final excerpt from this article:

Still, no one cares about correlations, or anything else really, until the markets head down.

Which brings me back to my comments on beta management and the SAA/TAA decision. You can rely on hedge funds to protect you in the event of a major market meltdown in the future. But if hedge fund correlations are strong and have been getting stronger in time as the markets have risen, who’s to say that the high correlations will remain during a major market decline? You buy insurance to save you during times of trouble. Investors who look at hedge fund investments as an insurance policy and choose accordingly should do better than those who look at them as return enhancers. In time, if hedge fund returns continue to have increased correlations (and even higher correlations) with broad indices, investors may take it upon themselves to provide their own appropriate “hedge”.

If ETFs represent some form of freedom or power to the individual investor, then perhaps they will be able to better protect themselves when the need arises. For some reason, I now recall old European and Asian sayings that power is great to have but can work against you without wisdom.

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

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

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

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

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

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

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

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

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

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

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

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