Taking advantage of downside market action in international and emerging markets can now be implemented through new ETFs from ProShares. No comments on this from me as I’ve already said for a while that the market has needed this so here’s the press release:

ProShares Launches First Short International ETFs

BETHESDA, Md.–(BUSINESS WIRE)–ProShares, the fastest-growing ETF provider this year, announced today the launch of the first-ever short international ETFs, designed to go up when a foreign market goes down. ProShares, the nation’s only short and magnified-exposure ETFs, recently crossed $9 billion in assets under management.

The six new ProShares, each to be listed on the American Stock Exchange, are:

ProShares		Daily Objective*	Ticker
Short MSCI EAFE		Daily returns equal to the inverse of the daily return of the MSCI EAFE Index	EFZ
UltraShort MSCI EAFE		Daily returns equal to two times the inverse of the daily return of the MSCI EAFE Index	EFU
Short MSCI Emerging Markets		Daily returns equal to the inverse of the daily return of the MSCI Emerging Markets Index	EUM
UltraShort MSCI Emerging Markets		Daily returns equal to two times the inverse of the daily return of the MSCI Emerging Markets Index	EEV
UltraShort MSCI Japan		Daily returns equal to two times the inverse of the daily return of the MSCI Japan Index	EWV
UltraShort FTSE/Xinhua China 25		Daily returns equal to two times the inverse of the daily return of the FTSE/Xinhua China 25 Index	FXP
* Before fees and expenses

The Short and UltraShort MSCI EAFE ProShares launched today; the remaining four are slated for release in November. After these launches, the Short ProShares lineup—providing short exposure to a wide range of domestic and international markets, capitalization sizes and investment styles—will number 35.

These launches follow ProShares breaking though $9 billion in assets under management after a significant market drop on Friday October 19. Initially launched in June 2006, ProShares had the most successful first year of any ETF company in history.¹

“The dramatic acceptance of ProShares has been fueled by investors looking to go beyond the basics and expand the strategies they employ in their portfolios. Shorting strategies have been used by serious investors such as institutions and hedge funds for years,” said ProShares Chairman and CEO Michael Sapir. “By introducing short ETFs to the marketplace—first on domestic market indexes and now on international—we have opened up opportunities for more investors to use short strategies to manage risk or to seek to benefit from market declines.”

Short and UltraShort ProShares offer many advantages over shorting baskets of stocks, individual stocks or ETFs. Investors can achieve short exposure without opening a margin account—buying short exposure is as convenient and simple as purchasing an individual stock. In addition, investors can lose only the amount that they invest, whereas when they short stocks, stock baskets or ETFs, their losses are theoretically unlimited. Moreover, these ETFs can be employed in vehicles that do not permit margin accounts—IRAs for instance. And finally, these ETFs can easily be tracked throughout the day.

Investors seeking to hedge gains should understand that they may need to make adjustments to their holdings to maintain a specific level of short exposure over time. Also, the funds have fees, expense and tax consequences of their own. These short ETFs are structured to provide the inverse of the daily performance of the market indexes that they track; that is, if MSCI EAFE declines by 1% in a day, the Short MSCI EAFE ProShares should gain 1%; if the index goes up by 1% in a day, the ETF should lose an equal amount. The UltraShort ProShares are designed to deliver twice the inverse of daily performance; in the above instance, where MSCI EAFE declined by 1% in a day, the UltraShort MSCI EAFE ProShares should appreciate by 2% and if the benchmark rose by 1%, the ETF should decline by 2%.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

• HSBC Climate Change Index

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

It’s not just me and this blog that’s back in action but the markets:

Since the bottom in late ‘02/early ‘03, we have seen dips followed by relatively quick erasing of the drawdown. Something as fundamental as poor credit practices looks now to be rather minimal in terms of market effect although 1) we’ll see just how accommodative the monetary authorities remains for the rest of 2007 and 2) we’ll see how the remainder of the year turns out as we’re yet to get the full reporting (latest quarterly earnings from the financial sector, inflation numbers, hedge fund performance numbers).

You’ll note that the dips are getting deeper but the time to recovery seems to be constant. We have V shapes that are only being stretched vertically. I’m a bit surprised that VIX hasn’t dropped back below 15. No forecasts from me now. After hurricanes, subway bombings and credit crunches, this global market has shown resilience that makes me think we’re well into the area where behavioral finance takes over. Kind of has that late 90’s feel (I’ll comment again on this below).

I have not submitted a blog entry since June 21st, nearly three and a half months ago. Is it me, or has it been relatively quiet in ETF land? Not to say that there haven’t been new products launched, there have been … some good and some not so good. But my feeling is that the conveyor belt has not only eased up on its acceleration rate but may have actually decelerated. If this is not true, someone please let me know. But if I’m right, then let’s all give a collective sigh. This pause in product launches should give investors of all types the time to reconfigure their processes to determine their investable universe and even tighten up their actual potential short list.

But don’t be mistaken. This pause is temporary. Although I may have been silent online, I have been in contact with many in the industry. We are going to see more from the big 3 (BGI, SSGA, Vanguard) although I’m thinking that PowerShares should be included in this group soon. However, the more interesting developments will come from the new entrants … some of them you have already heard of and others you likely haven’t. Some will provide exposures “with a twist” to asset classes already covered. Some will provide exposure to new areas of the capital markets.

It is the arrival of many smaller new entrants into this space that will provide what some will call innovation or differentiation while others might simply call (in aggregate) crap. I mentioned before about the feeling of the 90’s. If the new ETFs coming out focus on new ideas … there’s way too many to list so I might go over them one-by-one in future postings … then wouldn’t this new chapter in the ETF story be similar to the dot-coms? It’s simply the transfer of capital to new ideas, some that will work and some that won’t. Most of these new entrants have the backing of VC firms. You have to make your way to them to understand why they think their story is unique (i.e. why they have skin in the game). It’s pretty much the same idea on the hedge fund side. Except the manager doesn’t usually have the backing of a VC firm although they may be involved in some way (distribution). But the hedge fund is also about an idea. Unlike the ETF that provides (hopefully) a new or significantly meaningful market exposure, the hedge fund’s idea is about some new actively managed opportunity. I personally don’t see that significant a comparison with the dot com craze. The anti-ETF crowd surely sees it differently.

In this tough environment where getting paid for risk premium is suspect, it’s no surprise that we continue to hear about the growth of both ETFs and hedge funds. Hat tip to AllAboutAlpha for the latest commentary on this subject from InvestmentNews. Having now passed the half trillion dollar mark, you just have to wonder if the real asset growth of ETFs will be in the tried/true SPY-type behemoths or will the smaller players and new entrants be able to gain significant market share.

An interesting development is the cross border (or in most cases cross-ocean) movement of firms and operations. For example, SPA who is based in Europe have recently set up operations in the US. For those interested in the fundamental indexing approach from the likes of WisdomTree and PowerShares (via Research Affiliates), you’ll want to check out SPA and their fundamentally driven ETFs which are advised by MarketGrader who are based out of the US. I’d like to see this type of development (international operations) continue and the trend lead to more fluid trading of instruments. A good start would be to have NYSE-Euronext allow for a full ETF menu for US and European domiciled funds to be easily traded on a convenient online platform. We must be already headed that way.

I’ll find out additional information on these little tidbits and more in a few weeks at the “World Series of Exchange Traded Funds -West” conference in Scottsdale Arizona. From what I can tell, this should have a similar feel and scale as IMN’s similar event in Miami back in March. However, it won’t be as big as the upcoming “Superbowl of Indexing” which is also in Scottsdale and has more of an institutional investor bent.

For those of you who know me or have communicated with me in the past few months, you’ll know that I focused my attention on finding a new role for myself. My consulting work from earlier this year was meant to be a transition for me as was the blogging. One of the potential avenues open to me is writing. I have been given suggestions by several people about starting up a paid newsletter focused on ETFs. I remain cautious on this as there are a lot of these types of newsletters and there will surely be many more. In New York, I have spoken with a group that is interested in institutional level research of course with an ETF focus. Think I-bank but with an adamant spotlight on independence. One individual suggested that I have a 3-tiered service: free blog; low fee newsletter and top shelf institutional service. I just don’t know if I see myself in the online media business as all I’ve focused on in the past 12 years or so is the management of portfolios. It would be nice to do both (hence the blog), but you can only spread yourself so thin.

So, I have been speaking with a small number regarding possibly joining their organization. Some small, some large. This is where I have focused myself over the past couple of months. The upcoming busy conference schedule over the next few months helps in the networking so we’ll see how it goes. Like Yasser Anwar and various other bloggers who have spent far more resources than I have on their site (with surely more impressive results such as number of visits … mine is certainly a bare bones blog), I have found that as much as I enjoy blogging, the opportunity to turn this into a business is possible but likely not my path. The 3-tiered online service is something I have been thinking about for a while and I now have some potential partners to work on this with. But deep inside, I feel like that that would be a nice place for me to be AFTER I decide to stop managing money.

Let’s face it: This has got to be one of the most interesting times ever to manage portfolios. It’s a low yield world where it’s also harder to find alpha. This has forced sophisticated investors to explore new asset classes and strategies. This kind of thinking is making many market participants attempt to emulate others who are ahead of the pack … have you noticed how so many people online and in the mainstream press are talking about Yale’s endowment? We could certainly be in a point right now where the next ten years will have negative annual average returns.

For me, despite my focus on ETFs on this blog, I’m interested in the broader asset allocation problem. Writing about this just isn’t as much fun to me as compared to actually managing the money. So for now, I’ll put up the occasional blog posting here but hopefully I’ll be notifying you soon about where my career path takes me.