Claymore Calls Airline ETF a “Trading Product”

The basic investor take on the airline industry is that it’s a money pit, a sinkhole where money disappears into the sky, invisible and far out of reach, like the jets themselves. So, it seems odd that anyone would create a fund for investing in this sector of despair. But that’s exactly what Claymore Securities did Monday, launching the first U.S. airline ETF, the Claymore/NYSE Arca Airline ETF (FAA) based on the NYSE index of the same name.

While Claymore Securities offers some vanilla funds, the Wheaton, Ill., firm is the poster boy for the ETF industry trend of niche portfolios. Examples of Claymore’s family include the Clear Spin-Off ETF (CSD), which is comprised of companies that have been spun-off in the last two years; the Robb Report Global Luxury Index ETF (ROB), which tracks providers of luxury goods and services; and the Clear Global Timber Index ETF (CUT), which tracks companies that own or lease forested land or harvest timber for wood-based products. So, if anyone was going to produce the airline ETF, it would be Claymore.

With at least one airline seeming to be under bankruptcy protection or filing for protection each year, it’s not a great sector to be a shareholder.

“You really can’t make the case” for investing in airlines, Morningstar analyst Brian Nelson, told the International Herald Tribune last summer. He said he was more concerned about airlines staying in business than making a profit. “We’re not talking about long-term entities here. There is a probability that equity holders could be completely wiped out in bankruptcy in many carriers’ cases.”

Last year was an extremely hard year for the airline industry as jet fuel jumped from $2.70 a gallon at the beginning of 2008 to a historical high of approximately $4.25 by July. Add to that horrible customer service which includes the worst-on-time performance in history and surcharges for everything from higher fuel costs to basic services and amenities such as baggage check in, food and even pillows and blankets. The Amex Airline Index plunged 80% from its high in January 2007 to its July 2008 low.

But the industry itself isn’t going to disappear. It appears airline stocks have seen resurgence with the dramatic plunge in the price of oil. Since the July lows, the Amex Airline Index has climbed 53% through Tuesday. So, Claymore may have actually lucked out by launching their fund at one of the few good times to be entering the space.

Christian Magoon, Claymore’s president, says analysts are predicting that many airlines will post profits this year after huge losses in 2008. He points to three factors: the falling price of oil; aggressive reductions in capacity, 10% to 15% in some places, which have kept pace with falling demand and even created scarcity on some routes; and finally the fees for extra bags and other amenities are beginning to become a significant source of revenues for the carriers. Some are even saying this could be a banner year for the industry.

“The primary reason we brought this out is because this is a market with a large amount of volatility,” says Magoon. Still, he’s aware of the industry’s reputation and the possibility that oil prices will rise again dramatically. “We look at this as a trading product because of the huge volatility in the airline shares. It’s just a coincidence to have the renewed interest in the business.”

Magoon says the airline sector has huge trading volume because the trading community buys shares to take advantage of swings from “spike events.” He says he expects this to be more of a institutional product with a shorter hold time than less volatile ETFs.

That volatility has been on display most of this month. By Jan. 8, the Amex Airline Index had surged 97% from its July low, but over the last three weeks has fallen 22%. Last week, both AMR, the parent of American Airlines, the nation’s 2nd-largest carrier; and UAL, the parent of the third-largest, United Airlines, posted huge losses. AMR reported fourth-quarter losses surged to $340 million from $69 million a year earlier. Its shares fell 24% in one day. UAL posted a fourth-quarter loss of $1.3 billion vs. $53 million in the year-ago quarter, partly on poorly placed jet fuel hedges. Both blamed the continuing slump in air travel demand and suggested the global economic downturn would hurt their profit potential this year.

Then on Tuesday, Delta Airlines, the world’s largest carrier, posted a wider-than-expected fourth-quarter loss. $1.4 billion, compared with a loss of $70 million a year earlier. Delta’s shares fell 20% on Tuesday, sending the entire sector into a tailspin and dragged the Amex Airline Index down 7%

Robert Herbst, a commercial pilot who runs Airline Analysis says labor/contract issues, fuel cost instability and consumer demand will continue to be big issues for the industry this year.

Still, Claymore thinks this product will help it increase its market share in the ETF market. Claymore has the dubious distinction of being the first firm to close a significant amount of funds, sparking a slew of industry consolidation in 2008. Last February, it closed 11 underperforming ETFs. It was a mixed year for the firm as assets under management fell, but shares outstanding grew 20% with the launch of six new funds last year.

Still rumors have floated around that the firm is up for sale and had been in talks with closed-end fund giant Nuveen where Claymore chief executive David Hooten used to work. Magoon refused to comment on the rumors but said Claymore, which also runs closed-end funds and unit investment trusts, is committed to the ETF business for the long-term. He said many companies in the asset management business are evaluating their business models to see what partnerships can be implemented in order to become more successful in raising assets and they are looking at ETFs. Across the industry there are an unprecedented amount of conversations going on and Claymore has held talks with many firms in the search for new opportunities.

Magoon says the ETF industry will see more fund closings this year and fewer product launches. However, he adds that while people like to focus on the death of ETFs, he predicts a record amount of mutual funds will close in 2009, making this a much broader story.

With the airline fund, it’s first launch of 2009, Claymore currently has 34 ETFs on the market.

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