What the US can learn from Sweden about how to launch a bitcoin fund

Many Americans are tired of hearing about how Scandinavian societies have figured out how to do everything better than us, but here’s one more: how to launch a bitcoin fund.

The Securities and Exchange Commission and ETF companies can’t agree on how to bring a bitcoin exchange-traded fund to market. Just last week four prospective bitcoin ETF issuers withdrew their filings for new funds tracking the digital currency after the SEC shot them down, citing concerns about trading liquidity and valuation of underlying bitcoin futures.

But a Swedish company has proved how it can be done. It has successfully run a bitcoin exchange-traded product for the last two years that can be accessed by European investors in multiple countries, and the products have attracted more than $1 billion.

Stockholm-based XBT Providers launched its CoinShares series in 2015. The XBT Bitcoin Tracker One (COINXBT) trades in Swedish krona, while the XBT Bitcoin Tracker Euro (COINXBE) — they launched on the Nasdaq Stockholm in 2015. XBT also issued versions in Denmark, Finland, Estonia and Latvia. In the Swedish krona version, 200 shares equal the price of one bitcoin, and in the euro version 20 shares equal the price of one bitcoin.

The big difference between the successful Swedish launch and the impasse in the United States is the type of exchange-traded product: the XBT portfolios are exchange-traded notes (ETN), not exchange-traded funds.

An ETN is an unsecured debt instrument that promises to pay the pattern of returns of the bitcoin price. Ironically, despite being an unsecure instrument, the XBT product tracks the spot price of bitcoin by holding the actual currency and forward contracts in case of a liquidity shortfall.

“At that point in time, the ETN structure was the best route to bring the products to market,” said Laurent Kssis, chief executive officer of XBT Provider. “As a result of using this structure to bring the product to market, investors have been able to gain exposure to the price movement of bitcoin since 2015. This stands opposed to the U.S., where most investors are still waiting for access to bitcoin exposure via their normal brokerage account.”

There are three ways to construct a bitcoin portfolio

There are three different ways in which a firm could create a bitcoin exchange-traded product. It could create an exchange-traded fund that owns and stores actual bitcoins, similar to the SPDR Gold Shares ETF (GLD). GLD tracks the spot price of gold by holding physical gold bricks in bank vaults in London. The second way is a bitcoin futures ETF, which approximates the price of bitcoin by owning bitcoin futures products. That’s been the dominant paradigm for SEC filings, including the ones recently pulled, due to the recent uptick in bitcoin futures contracts offered by major U.S. exchanges and securities firms.

“I think using the ETN structure to launch a bitcoin product was a good fit,” said Arlene Reyes, chief operating officer of Exchangetradedfunds.com, a website that reports on global ETFs. “ETNs are unsecured instruments backed by the credit of the issuer, and it tracks the performance of the underlying asset. … XBT Provider holds bitcoins equal to the value of ETN shares issued and tracks the performance of the price of bitcoin. I can see how this structure would be attractive to regulators.”

“I don’t know why an ETN hasn’t been done yet. We know other people are in discussions to make one, but it’s not us. We know it’s being talked about.” -Garrett Stevens, chief executive officer of Exchange Traded Concepts

This past October, XBT came out with two more ETPs to track the second most highly used cryptocurrency, ether, in both Swedish krona and euros: Ether Tracker One (COINETH) and Ether Tracker euro (COINETHE). These also are listed on the Nasdaq Stockholm for European investors.

One of the ETF companies that filed for a bitcoin ETF has looked at the ETN route and says others have been talking about it as well.

“We have considered notes with regards to bitcoin, but we have not had the opportunity,” said Garrett Stevens, the chief executive officer of Exchange Traded Concepts, which worked with REX ETF on a rejected bitcoin futures fund. “But we are a white-label company and we do what someone else wants. That’s what the REX guys wanted, so that’s what we created. I don’t know why an ETN hasn’t been done yet. We know other people are in discussions to make one, but it’s not us. We know it’s being talked about.”

There is one product that currently gives U.S. investors access to the bitcoin market — the Bitcoin Investment Trust (GBTC), managed by Grayscale Investments. However, GBTC is not an ETF, despite press reports. It’s not SEC-registered, and it trades on the Nasdaq over-the-counter markets. It’s highly volatile and can trade at an extreme premium to the price of bitcoin. Some brokers, including Merrill Lynch, are refusing to sell GBTC and other bitcoin-related securities to their clients.

Because they trade on an exchange, products like ETFs and ETNs are not only priced using a net asset value (NAV) — the value of securities held minus liabilities and divided by shares outstanding — that is calculated at the end of each day and by intraday NAV (iNAV) throughout the day. They also have a current market price, which can be more (a premium) or less (a discount) to actual value. The more volatile a market, the more likely there is to be a premium/discount issue.

“The [XBT] products are very well designed for what they do. They deliver, unlike GBTC,” said Matt Hougan, the chief executive of Inside ETFs, an ETF education company. “They give exposure to the returns of bitcoin and ether pretty well. I think they were well executed and they’ve done their job.”

But Michael Sonnenshein, managing director of Grayscale Investments, remains positive. “We are thrilled about the response of the market to the Bitcoin Investment Trust since it became publicly quoted in 2015,” he said. “My team is looking forward to bringing our second vehicle, the Ethereum Classic Investment Trust, to the OTCQX market in second quarter of 2018.”

Some ETF experts believe the chances remain good for a bitcoin ETF to be approved this year.

Before the crash, ETNs were more popular in the US

ETNs were once among regular exchange-traded product launches in the United States, though never at the level of exchange-traded funds in number of portfolios or assets raised. They were more popular with banks as issuers — which had the existing debt businesses to structure the credit side of the investment — than with standalone asset-management companies.

Before the financial crash, there were dozens of ETNs that covered commodities sectors, and many still exist today. But ETNs became less popular after the financial crash, based on the theoretical risk that a failure like Lehman Brothers could expose ETN investors to severe credit risk. While the theoretical risks did not play out, ETNs waned in popularity among new launches.

At the end of 2008, near the depths of the fiscal crisis, there were 74 ETNs, totaling $3.6 billion in assets under management. By the end of 2017, there were 204 ETNs, with combined assets of $24.9 billion, according to ETF.com

ETF companies that have filed for bitcoin ETFs, including REX, Proshares, Van Eck and Direxion declined to comment. Gemini, the investment company of the Winklevoss twins, did not respond to a request for comment.

Like the U.S.-based GBTC, the XBT bitcoin ETNs typically trade at a premium or discount to the actual price of bitcoin, but the range has been much smaller than in the case of GBTC, between 1 percent and 3 percent.

According to Bloomberg, the 52-week average percent premium is 0.46 percent, but it has been as high as 21 percent and as low as negative 16 percent. Still that’s a far cry from the 65 percent premium seen on GBTC.

“What Laurent has proven is the ETN structure has worked and been able to deliver that pattern of returns that’s different from the two paradigms filed with the SEC, which is the physical and the bitcoin futures products,” Hougan said. He also thinks the premium/discount issue is being handled fairly well in the case of XBT’s bitcoin portfolios.

“Bitcoin is an expensive product to trade, custody, store and service at this point. So I don’t think a 3 percent premium in the ETN is absurd,” he said. “That makes the ETN a viable approach.”

Currently, the two Bitcoin Trackers combined (krona and euro) have total assets of $900.8 million, and the two Ether Trackers have total assets of $439.3 million.

—By Lawrence Carrel, special to CNBC.com

Passive Index Funds Pushed To Be More Active Voice For ESG

Until recently, socially responsible investing has been a backwater in the investing world. But investors — particularly activist groups — now demand more environmental, social and governance (ESG) responsibility from corporations.=

According to a survey by Brown Brothers Harriman and ETF.com, 51% of investors say ESG carries some level of importance, up 14 percentage points from last year. There are 169 ESG mutual funds and 56 ESG ETFs, according to Morningstar.

“It’s definitely being driven by investor feedback or the appearance that you want to be ahead of the game on this,” said Scott Sacknoff, chief executive of SerenityShares, which manages the ESG-focused SerenityShares Impact ETF (ICAN). ICAN, which launched in April, has $4 million in assets and an expense ratio of 0.5%.

ESG’s increasing popularity has raised questions about whether stock and bond index fund managers could and should be doing more to use proxy votes to steer companies in the indexes toward higher ESG standards.

Morningstar recently published a paper examining the issue, “Passive Fund Providers Take an Active Approach to Investment Stewardship.”

The paper found that while European managers have been active for years through the two stewardship tools of engagement with corporate management and proxy voting, index managers in the U.S. and Japan have only recently begun this process.

Of the five U.S. fund managers surveyed, BlackRock, Vanguard, State Street Global Advisors, and Fidelity Investments said they were increasing their engagement efforts, despite the costs. Only Charles Schwab (SCHW) said it would not.

“While we don’t meet with individual companies, we do engage with issuers in a systematic way through our proxy voting,” a Schwab spokeswoman told IBD. “We have yet to see evidence that with a portfolio as large as ours (by number of companies), direct engagement would provide measurable improvements for shareholders.”

The Morningstar paper addresses the main issue: “It may be tempting to assume that (since) index managers are passive owners (they) have little incentive to devote resources to monitoring companies; after all, they tend to compete on fees and their primary objective is to match the performance of indexes.”

Another issue is that since index managers have no choice in the stocks they hold, why should they care what the companies do?

“That’s why we say they have a duty to influence these companies to promote better ESG policies,” said Hortense Bioy, Morningstar’s director of passive fund research in Europe and the report’s co-author. “Because they are stuck with these companies. They are long-term investors, and they own everyone in the market. So they have a unique responsibility to change these companies for the better. That is the whole argument. As opposed to active managers, who if they disagree with the way a company is run, they could just divest it and not care, and only invest in the ones they believe will outperform the market.”

While for the most part, index managers vote with corporate management, sometimes their huge shareholdings can result in visible change. In 2016, a shareholder proposal asking ExxonMobil to be transparent and disclose its risk to climate change wasn’t backed by BlackRock. Instead, BlackRock held private discussions with the oil company’s management asking for the same thing as the activists. But it saw no results, so in 2017, when shareholders put forth the same proposal, BlackRock publicly voted for it, helping it pass.

“BlackRock believes that engagement is the best way to drive change on important environmental, social and governance issues,” said BlackRock spokesman Ed Sweeney, adding the firm has been doing this since 2011. “As a long-term investor, we are willing to be patient with companies when our engagement affirms they are working to address our concerns. However, our patience is not infinite — when we do not see progress despite ongoing engagement, or companies are insufficiently responsive, we will vote against management. We view a vote against management as a sign of a failed engagement, not as the start of the process.”

While large asset managers are favorite targets of activist groups, their pressure doesn’t always bear fruit. In November, an activist shareholder group proposed that Vanguard Group divest itself of PetroChina and Sinopec Shanghai, two Chinese energy firms doing business in Sudan. The group accused the companies of genocide. Vanguard recommended its shareholders vote against the proposal. The proposal failed.

But what about returns?

“ESG started not to improve the world, it was started by big banks to get a handle on risk,” said Janet Brown, president of FundX, a San Francisco RIA, and manager of the FundX Sustainable Impact Fund.

“Research shows higher ESG scores lead to more efficient, better earning companies,” Brown said.  “About 2,000 academic studies show a positive correlation between higher ESG and positive returns.” She was citing a study in the Journal of Sustainable Finance & Investment published in 2015.

It’s not just academic studies. A 2017 survey by State Street found that more than 68% of institutional investors reported that integrating ESG into their process had “significantly improved their returns.”

Money Managers Lure Millennials With Low Minimums, Live Advice

The traditional financial advisor rarely takes on new clients with a nest egg smaller than $100,000.

But the financial advisory industry is coming up against two large speed bumps that could spark a paradigm shift: the rise of the robo-advisor and the fact that the second half of the millennial generation is entering the workforce and starting to invest.

This has led one registered investment advisor to rethink its strategy for acquiring clients. M&R Capital Management is a 24-year-old firm with $500 million under management. The New York-based RIA — which manages money for individuals, institutions and charities — typically requires $250,000 to open a separately managed account (SMA). Its average SMA rose 13.05% in the past year and for the past three and five years returned an average annual 2.89% and 6.26% respectively, M&R says.

However, the firm’s members realized their growth strategy needed to focus on the millennial generation. With many millennials still in their early to mid-20s, few have the nest egg to open an SMA. Most don’t even have savings.

But the few sophisticated enough to invest are looking at the same place where they do their shopping and banking — the computer — and opening accounts with robo-advisors.

So M&R Capital decided to lower its account minimum. It created Prime Funds, a set of ETF-based model portfolios in which people could open an account with as little as $500.

“This is our way to compete with the robo-advisor,” said Paul DeSisto, director and senior portfolio manager at M&R. “The idea was to get young workers. People who don’t have much money to invest and get them invested right away with some safety and growth.”

DeSisto said the idea is to make them clients when they are small investors, help them grow large portfolios, then 15 or 20 years later move them into an SMA.

“We feel that people still want to talk to somebody,” said DeSisto. “They can call at any time and have access to the portfolio managers.”

M&R is able to accept such small accounts by keeping costs low. Prime Funds clients only have a choice of three portfolios. M&R uses the Pershing FundVest ETF platform, which lets M&R trade ETFs commission-free. The clients can’t trade ETFs on their own. M&R charges each account an annual fee of 1%. That’s on top of the fees that the ETFs charge, which range from 0.15% to 0.57% of assets a year.

The three portfolios currently available are: growth, value, and equity income.

The growth portfolio consists of a 42.5% allocation of PowerShares Dynamic Large Cap Growth Portfolio (PWB), 15% SPDR S&P 400 Mid Cap Growth (MDYG), 32.5% SPDR S&P 600 Small Cap Growth (SLYG), and 10% PowerShares S&P International Developed Quality Portfolio (IDHQ).

The value portfolio consists of PowerShares Dynamic Large Cap Value Portfolio (PWV), Oppenheimer Mid Cap Revenue ETF (RWK), SPDR S&P 600 Small Cap Value (SLYV), and IDHQ.

The high-distribution equity-income portfolio is comprised of PowerShares S&P 500 High Dividend Low Volatility Portfolio (SPHD), SPDR S&P 400 Mid Cap Value (MDYV), PowerShares S&P SmallCap Low Volatility Portfolio (XSLV), and IDHQ.

The funds have been up and running since July 31. Through the end of September, the growth portfolio has a return of 6.1% and $95,000 in assets. The others don’t have assets yet.

While it’s not a full-blown trend, M&R isn’t alone in taking on clients with small accounts. Some, like Jeremy Torgerson, the founder of nVest Advisors, an RIA in Denver, has been taking on small accounts for two years because he sees how the robo-advisor technology is overrunning the industry. He offers his clients five ETF-based model portfolios.

“I’ve structured my practice to be a touch of robo and a touch of human to hold their hands,” said Torgerson. “If you get these people on the ground floor and be there for them, you will have a lifelong client.”

Hunter von Unschuld, the founder of Fractal Profile Wealth Management, an RIA in Albuquerque, N.M., retired as an attorney in 2013 and has been managing money since. He won’t turn anyone away — and offers eight ETF-based portfolios.

“We take small accounts because it’s my belief that everyone that needs help with their finances and retirement planning should be able to get help no matter their account size,” he said.

This was originally published in Investor’s Business Daily.

Schwab Survey Shows Which Generation Has Taken to ETFs the Most?

Investors’ knowledge and use of exchange traded funds nearly doubled over the past five years, and 42% expect ETFs to become their primary investment vehicle in the future, according to Charles Schwab’s 2017 ETF Investor Study.

The seventh annual study interviewed 1,264 investors in June between the ages of 25 and 75. They needed to have purchased an ETF in the last two years and have at least $25,000 in investable assets.

Eight percent of the investors said their portfolios already consist of only ETFs and 43% would consider holding only ETFs instead of individual securities.

The millennials generation has taken to ETFs the most — 56% of them say they’re their investment vehicle of choice. Among the members of Generation X, 44% said ETFs were their favorite vehicle; for baby boomers it was 30%; and for matures, those older than baby boomers, it was 23%.

Of millennials, 60% expect ETFs to be their primary investment vehicle in the future. That drops to 45% among Generation X, 23% among baby boomers and 17% for matures.

At least some financial advisors are scratching their heads over the survey results.  “I haven’t found that to be the case,” said Robert Karn, president of Karn Couzens & Associates, a registered investment advisor in Farmington, Conn. “Many of our clients have heard about ETFs, but they don’t know what they do. I don’t see millennials leading the charge. I don’t see in my practice what they’re saying in the survey.”

A low expense ratio is the most important factor in choosing an ETF, according to 62% of the respondents. Total cost was second, followed by, in declining order, the ETF provider’s reputation; how well it tracks its index; its historical returns; its liquidity/trading volume; if it’s commission-free; its exposure to a specific part of the market; its Morningstar rating; and finally, its total assets.

Investors are placing increased importance on the ability to trade ETFs without commissions. This year 55% said working with a brokerage that offered commission-free ETFs was very or most important, up from 38% in the 2012 survey.

Only 1 in 10 currently invest in socially responsible investments (SRI), 55% say they’ve heard about SRI and 35% don’t even know what SRI is. However, interest in SRI is growing. About 51% of the respondents said they would invest in SRI strategies if more education on products or asset allocation were provided.

Still, almost half of the ETF investors said it was important to them to invest in funds that align with their beliefs, 30% said they would actively seek out socially responsible funds and 42% preferred a strategy that was tailored to their values. About 53% said they had a “pretty good understanding” of how socially responsible their investments are and 46% said it was important to invest in socially responsible funds because they want their investments to align with their beliefs.

Interest in SRI investing is highest among millennials at 48%. Only 32% of Gen X investors seek out SRI strategies. That drops to 14% for baby boomers and 9% for matures.

“It surprised me how it reinforced my understanding of the demographic tilt toward ETFs,” said Steven Schoenfeld, founder and chief investment officer at BlueStar Indexes, which provides the benchmarks for the VanEck Vectors Israel ETF (ISRA) and the ETF Managers Trust BlueStar TA-BIGITech Israel Technology ETF (ITEQ). “It shows the appeal when people see they can do almost as well, if not as well, by aligning their values. It just makes them feel better and might make them better investors if their connection is more than just better returns. Then when the market gets volatile they might stick with it.”

With smart beta, 29% of the respondents said they currently invest in smart beta strategies and 59% said they planned to increase their investments in smart beta in the next year. About two-thirds of ETF investors have reduced active exposures over the last three years and replaced them with smart beta exposures.

This was originally published in Investor’s Business Daily.

ETFs That Track Gold Having A Better Year Than The Stock Market

fter a midsummer rally, gold is now having a better year than the S&P 500 index. And that’s good timing for some new gold ETFs that launched this year.

SPDR Gold Shares (GLD), the largest and oldest ETF in the world which tracks the price of gold, has surged more than 10% since July 7 for a year-to-date return of 16.9% through Sept. 7, according to Morningstar Direct. Meanwhile, SPDR S&P 500 (SPY), which tracks the stock market benchmark, is up 11.5% this year. IShares Gold Trust (IAU), GLD’s main competitor, is also up nearly 17%.

The main reason for the rally is the falling U.S. dollar, which has dropped nearly 10% this year. Some blame comments from President Trump, who said in April that the dollar was “getting too strong.”

But others think it has more to do with interest rates.

“Real interest rates started to go negative and that hurts the dollar. Both the five-year and the two-year (Treasury notes) are now negative,” said Frank Holmes, CEO and Chief Investment Officer of U.S. Global Investors, which launched U.S. Global Go Gold & Precious Metal Miners (GOAU) in June. “When the dollar falls, gold goes up.”

GOAU holds companies engaged in the production of precious metals either through mining or production and specialized financial firms called royalty companies. These royalty companies provide capital to fund exploration and production projects, and in return, receive a stream of royalties. GOAU is up 14% since its launch. It carries an expense ratio of 0.60%.

GraniteShares Gold Trust (BAR) also launched this year, on Aug. 31. Just like GLD and IAU, it holds actual gold bars to track the price of gold. Founded by Will Rhind, who managed GLD for 2-1/2 years before starting GraniteShares, BAR’s big selling point is it’s the lowest-cost gold ETF. It charges an expense ratio of 0.20%, vs. 0.40% for GLD and 0.25% for IAU.

“When you own gold as a hedge, you want the lowest-cost hedge,” said Rhind.

People flock to gold as a hedge when there’s uncertainty in the market. And there had been a lot of uncertainty lately, including deadlines to keep the government funded and raise the debt ceiling.

The Senate on Thursday approved a bill to avert a government shutdown and raise the debt ceiling for three months, as well as $15.25 billion in hurricane relief aid. In August, the president had said he was willing to risk shutting down the government unless he obtained funding for the wall he promised to build between Mexico and the U.S.

Gold hit its all-time high of $1,900 in 2011, during the last government shutdown threat.

“Another key motivation is we’re entering crash season, September and October,” said Brandon White, gold analyst at Bullion Management Group in Toronto. “We haven’t had a (stock market) correction for a number of years. So, people think we may be due for a downturn. So, take money off the table and move it into something that does well in market downturns, and precious metals do well.”

He added that annual gold production is expected to decline 40% going into 2018.

Then there is the saber rattling between Trump and North Korea, which is testing nuclear bombs and firing missiles. Wars always make gold prices go higher and geopolitical tensions are rising between the two countries.

All this has pushed the price of gold through the technical resistance line of $1,300, to $1,349 an ounce.

“A lot of people watching gold have been waiting for gold to challenge the $1,300-resistance line. It was tested three times last week,” said White. “When money managers consider an asset to revert to the upside from a downtrend, they will often wait for a 20% move. The resistance line was a key technical indicator that needed to be broken before sentiment turned. Now interest is back. It’s not so much a speculative trade as a defensive trade.”

And interest is definitely back.

Gold-backed ETFs saw net inflow of $1.6 billion in August, according to the World Gold Council. North American ETFs drove global inflow. GLD led inflow with $1.03 billion, or 3.2% of its assets under management, and IAU received $266 million, or $3.1% of AUM.

What Happens When HACK Gets Hacked By Insider

Investors in the PureFunds ISE Cyber Security ETF (HACK) woke up Aug. 1 to find their fund had a new name, ETFMG Prime Cyber Security ETF, and tracks a new index.

a stunning development, the fund’s advisor, ETF Management Group, had rebranded the entire family of PureFunds ETFs with the ETFMG name, and began following indexes from a new firm called Prime Indexes.

Since the change, $36 million has flowed out of HACK, which has $1.1 billion in assets, according to Morningstar Inc. The outflow has coincided with a pullback in cybersecurity stocks and the ETFs that invest in them.

While HACK’s old and new indexes both track the same securities, there were some slight changes in the new index to conform with a new methodology and improve implied liquidity, said Sam Masucci, chief executive of ETF Management Group. The change had little effect on the share price.

The story highlights the issues small asset managers without infrastructure can run into. ETF MG is known as the advisor. It provides the infrastructure for operating the ETF and portfolio management, as well as manages the third-party relationships with outsourced services, such as custodians, legal and auditing. ETF MG has 13 funds on the market.

PureFunds was the sponsor, covering most of the costs. Typically, the sponsor’s role is branding, marketing and consumer education. ETF MG is now the sponsor.

Unlike the ETFs of most small asset managers, when HACK launched in 2014 it was an immediate hit. It quickly gathered $1 billion in assets. Andrew Chanin, Pure Funds’ chief executive, was lauded as an ETF wunderkind. Altogether, PureFunds launched eight funds with ETF MG, six of which will continue under the ETF MG name. The other two were closed in July.

“People come to us with ideas that we turn into ETFs and operate. We are a comprehensive service company,” said Masucci. “Their role is market education. With more than a dozen partners, we’ve only had one that went this direction.”

Masucci said the dispute started in April when the board voted to lower the fund’s expense ratio to 0.6% from 0.75% in order to better compete with First Trust Nasdaq Cybersecurity ETF (CIBR), which charges 0.6%. At the point, HACK had $950 million in assets, while CIBR had $218 million.

“I alerted Andrew, and the Nasdaq and Andrew sued us,” said Masucci. “When Andrew sued us he violated provisions in our agreement precluding him from taking any actions that interfered with the operation of the fund. We would have not terminated them if they had not sued us.”

Masucci also said that Chanin did not originate the idea for the fund. He said that came from Kris Monaco and his team at ETF Ventures, a division of ISE, which was later acquired by Nasdaq. Masucci said Nasdaq disbanded the ETF Ventures team. Monaco, who was instrumental in creating the index that PureFunds ISE Cyber Security tracked, is one of the founders of Prime Indexes, which is providing the new index for the fund.

Chanin disputes the claims by ETF MG. He said PureFunds and ISE were partners and they hired ETF MG, not the other way around. And that it was PureFunds and its partners that helped cover the fund’s expenses.

In the complaint filed in the Superior Court of New Jersey, PureFunds claims that ETF MG was retained to “empower” PureFunds to launch their ETFs. PureFunds alleges that ETF MG “trumped up false securities violations” with the purpose of obtaining control of the PureFunds business to pocket millions in annual revenue. It also alleges that ETF MG reduced the “profit” that PureFunds was to receive from “their ETFs.”

“The pressure on asset managers to reduce their fees is as great as it’s ever been,” said Ben Johnson, Morningstar’s director of global ETFs research. “The vast majority of flows are going into the ones with absolute rock-bottom expense ratios. That’s the trend.”

HACK has risen 10.4% this year, but is down 4.8% in the past three months. CIBR, which was launched in June 2015, is up 8.3% this year, but also down 4.8% the past three months.

CIBR now has $275.6 million in assets.

The two funds have similar top holdings. HACK’s 39 holdings as of Aug. 15 were topped by Cisco Systems at 4.75%, Palo Alto Networks at 4.49% and Symantec at 4.12%. CIBR top holdings were Palo Alto Networks at 6.87%, Cisco Systems at 6.31%, and Akamai Technologies at 6.09%.

The other funds affected by the change, with assets and expense ratios:

• PureFunds ISE Mobile Payments is now ETFMG Prime Mobile Payments ETF (IPAY), with $152 million in assets and an expense ratio of 0.75%.
• PureFunds ISE Junior Silver (Small Cap Miners/Explorers) is now ETFMG Prime Junior Silver ETF (SILJ), with $53.1 million and 0.69%.
• Pure Funds Video Game Tech is now ETFMG Video Game Tech ETF (GAMR), with $29.7 million, 0.75%.
• PureFunds Drone Economy Strategy is now ETFMG Drone Economy Strategy ETF (IFLY), $23.3 million, 0.75%.
• Pure Funds ETFx HealthTech is now ETFMG ETFx HealthTech ETF (IMED), $2.8 million, 0.75%

This was originally published in Investor’s Business Daily.

Why Shark Tank’s Mr. Wonderful Puts Most Of His Cash In ETFs

When people see Kevin O’Leary, Mr. Wonderful on the TV show “Shark Tank,” they see a man willing to invest thousands of dollars in risky startups based on only a 10-minute presentation.

But the truth is, O’Leary’s a man who’s invested the bulk of his fortune in ETFs. In addition to “Shark Tank,” he heads O’Shares, an ETF family created to meet his specific investing needs.

The seven ETFs track indexes created by FTSE Russell that follow O’Leary’s investing criteria. Each company in the indexes must have 1) attractive operating metrics as defined by return on assets; 2) 20% less volatility than the market; 3) pay dividends. The portfolio must have no more than 5% in any one company and no more than 20% in a sector.

“People see me on ‘Shark Tank’ and think I’m the Wild West,” said O’Leary. “But I’m not. I’m an extremely conservative investor. My concern is preservation, and I want to make 5% a year forever. It’s not easy to do.”

O’Leary made his millions as a founder of Softkey, a publisher and distributor of CD-ROM-based software. It later bought Learning Co. and took its name. In 1999, Mattel acquired the company for $4.2 billion.

He put most of that money into a trust for his children that would pay out 5% every year in perpetuity. He wanted the trust invested 100% all the time and rebalanced every January back to 50% equity and 50% fixed income. He used the five investing criteria he would later use for the ETFs and said there could be no leverage or derivatives.

The annual 5% payout couldn’t come from return of capital, only interest, dividends or capital appreciation. When bonds paid 6.5%, the target 5% payout was easy to make. But as the yield on U.S. Treasuries fell, making 5% became a challenge without inordinate risk.

“Over the years, I’ve used every asset class: private equity, hedge funds, even alternative asset classes like owning forests,” said O’Leary. “You name it, I’ve done it.”

He said he found it interesting and frustrating that no matter who he hired or how successful, after about seven years, the manager’s strategy would blow up or go flat. He then decided to build his own mutual funds, and noted that his managers were using ETFs to “plug holes in periods where they needed to do allocations.” He tried to use ETFs for his trust, but every index violated at least one of his criteria, usually an outsize weighting in one stock.

He then went to the folks at FTSE Russell and asked them to make an index based on his criteria that would cover the equity portion of the stock/bond portfolio. They said “no.” They don’t make indexes for individuals, but they would test his idea to see if it had market potential. Out of that came O’Shares FTSE U.S. Quality Dividend ETF (OUSA). While capital preservation and yield are the fund’s mandate, not benchmark outperformance, in 2016 it beat the S&P 500: 12.3% vs. 11.96%. The yield on OUSA is 2.3%, compared with the S&P’s 1.9%. The expense ratio is 0.48%.

“Kevin’s approach to looking at dividend growth and cash flow is something that we think adds benefit to our equity weightings,” said Rob Stein, chief executive at Astor Investment Management, a Chicago RIA with $2 billion under management. The firm builds portfolios exclusively out of ETFs. “We believe O’Shares’ approach makes sense for analyzing stock selection, so we don’t have to drill down in individual stock selection. It’s a concept that makes sense to us and it’s being done rigorously.”

For geographic diversification, O’Leary asked FTSE Russell to build O’Shares FTSE Europe Quality Dividend ETF (OEUR) and a currency-hedged version O’Shares FTSE Europe Quality Dividend Hedged ETF (OEUH), which removes the effect of currency fluctuations. Then came O’Shares FTSE Asia Pacific Quality Dividend ETF (OASI) and its hedged version O’Shares FTSE Asia Pacific Quality Dividend Hedged ETF (OAPH). In 2016, OASI beat the MSCI AC Asia Pacific Index 7.82% to 5.21% and yielded 2.8%.

O’Leary then asked Russell to build O’Shares FTSE U.S. Small Cap Quality Dividend ETF (OUSM).

While on “Shark Tank,” O’Leary has invested in 40 companies, but he said he wouldn’t put any of them in his trust. They are too high-risk.

“I love the ETF industry and the innovation that is going on in it,” said O’Leary. “And I’m proud to be a part of it.”

Originally published in Investor’s Business Daily.

Interactive Brokers Aims For Best Platform, Lowest Price

Interactive Brokers Group has broken into the top ranks of online brokers, excelling in several categories deemed important to investors.

Interactive (IBKR) joins four other brokers in the top five for overall customer experience in Investor’s Business Daily’s annual ranking of online brokers.

The nation’s largest electronic broker in terms of daily average revenue trades, Interactive won top marks for low commissions and fees, trade reliability, site performance, equity trading tools, mobile platforms/mobile trading opportunities, options trading platform, portfolio analysis and reports, and ETF choices.

The message seems to be getting out to investors. In 2015, when the stock market ended slightly lower, the Greenwich, Conn., company saw the number of accounts grow by 18%, and 1% in December alone, to 331,100. Client equity increased 19% year over year to $67.4 billion.

Comprising two segments, a global electronic broker and a market maker, the firm processes trades in securities, futures, foreign-exchange instruments, bonds and mutual funds on more than 100 electronic exchanges around the world.

Hungarian immigrant Thomas Peterffy founded the firm in 1977 and launched the Interactive Brokers platform in 1995. Since then it has become one of the leading brokers for professional and semiprofessional investors, as well as institutions.

Biggest And Cheapest Broker

Still serving as chairman and chief executive, Peterffy said his firm is the largest and least-expensive stock broker in the world. In December 2015, the firm recorded 628,000 DARTs and an average commission per client order of $2.09 for securities and $6.33 for options. For orders of 100 shares, it charges just $1. He also said the average amount charged for a margin loan is 1.3%, which undercuts all of the firm’s competitors.

“Our philosophy is to offer the best platform at the lowest price,” Peterffy said in an interview with Investor’s Business Daily. “We don’t sell our customers orders, but seek to execute them at the best possible price. The total transaction cost on 2.5 trillion stocks, including market impact and fees, was 0.8 basis points.”

He said the firm sits in a sweet spot between investment banks and online brokers.

“The online brokers don’t need all the sophisticated stuff we provide, and the big investment banks will not take people with less than $5 million,” Peterffy said. “Our target clients are sophisticated individuals or institutional traders and investors.”

Over the past year, Interactive added a lot of research, news providers and analyst ratings to the platform. It also introduced a portfolio builder that allows clients to screen stocks based on fundamental and technical data, assemble portfolios that automatically rebalance and lets them back-test the portfolio’s performance over various time periods.

Investor’s Marketplace

Another feature Interactive introduced last year to help set itself apart is transparency. Interactive now lets clients see the number of shortable shares available in real time without having to call the broker. It also lets clients see the lending rate at which stocks may be borrowed to be shorted. You won’t find this at the wirehouses.

In 2015, it also launched a service called the Investor’s Marketplace, which gives clients one-stop shopping access to investors and third-party service providers around the globe. It’s a place where traders, investors, financial advisors, fund managers, research analysts, technology providers and business developers can advertise, explore and do business with each other.

Part of the Investor’s Marketplace will be the Hedge Fund Marketplace, where qualified investors may view and download information posted by participating hedge funds, including private placement memoranda, subscription information and performance summaries.

As of June 2015, the Marketplace had more than 300 advisors, brokers, money managers and hedge funds, 120 research providers, 75 administrative service providers and 295 participating technology providers.

In 2016, the company planned to relaunch Covestor, an online money manager it acquired in 2015. Covestor lists money managers and traders who run investment portfolios. Clients will be able choose a money manager and set up accounts that mirror the managers’ portfolio, essentially trading along with the manager.

To View IBD’s Full Best Online Brokers Report

This was originally published in Investor’s Business Daily.

Emerging Market ETFs Rally in Spite of Trump Trade Threat

In the wake of Donald Trump’s election, emerging-market ETFs tumbled as investors feared that the new administration’s protectionist trade policies would hurt the countries in these markets. But then a funny thing happened. After ranking as one of the worst-performing sectors in the last quarter of 2016, emerging- market ETFs began the new year with a rally and are outperforming U.S. stocks.

So far this year, Vanguard FTSE Emerging Markets ETF (VWO) has jumped 10%, iShares Core MSCI Emerging Markets ETF (IEMG) leapt 10%, and the iShares MSCI Emerging Markets ETF (EEM) climbed 10% vs. 5% for the SPDR S&P 500 (SPY).

Part of the reason is that prior to the election, 2016 had been a pretty good year for emerging markets. Because many emerging markets are tied to commodities, the prior four years had been pretty bad because of falling commodity prices and slowing growth in China. But in 2016, commodity prices began to rise and China’s economic slowdown stabilized.

A big part of the postelection drop was out of concern for the economy of Mexico should Trump attempt to renegotiate Nafta and anxiety over trade barriers with China, according to Mitch Tuchman, chief investment officer at Rebalance IRA, a retirement investment advisor, in Palo Alto, Calif.

Robert Johnson, Morningstar’s director of economic analysis, said the recent performance is a continuation of last year’s rally. He also said companies and investors have begun to think that, in the wake of Trump’s mishandling of the immigration ban, he might not be able to implement his trade policies, especially as he gets pushback from industries hurt by trade bans and tariffs.

Also, since the trade policies haven’t yet been defined and investors think most emerging markets, besides Mexico and China, won’t be affected, they’re jumping back in.

“After five years of underperformance, emerging markets were oversold, and the election flushed out the remaining people hanging on,” said Gerald Laurain, chief investment officer with FTB Advisors, an RIA in Memphis, Tenn., with $4 billion in assets under management. “So now that they’ve established a low, the only place to go isup.”

J.J. Feldman, a portfolio manager at Miracle Mile Advisors, a Los Angeles-based RIA, said the valuations are much more compelling. The price/earnings ratio on the emerging markets is 12 vs. an expensive 18 on the S&P 500. He added that emerging- market stocks are yielding 2.25% vs. the S&P’s 2%.

Peter Schiff, CEO of Euro Pacific Capital, an asset manger in Westport, Conn., has a different angle. “When there is protectionism, America is the loser,” he said. “And tariffs will backfire. People are making the connection that it will weaken the dollar. Meanwhile, the euro is bottoming out and that is better for emerging markets.”

“Europe seems to be doing better, and it’s more important to China than the U.S.,” said Johnson. “There’s better growth there, no new rules and other markets they can sell into.”

So far through this year, the top country-specific ETFs are all in emerging markets. IShares MSCI Brazil Small-Cap (EWZS) has soared 30%, VanEck Vectors Brazil Small-Cap (BRF) surged 26%, iShares Brazil Capped (EWZ) is up 18%, Global X MSCI Argentina (ARGT) up 16%, and KraneShares CSI China Internet (KWEB) up 16%.

After a brutal two-year recession in Brazil, during which President Dilma Rousseff was impeached and replaced by Michel Temer, the country is finally expected to be on the road to recovery. Finance Minister Henrique Meirelles expects the Brazilian economy to return to a 2% annual growth pace by the last quarter of the year. Wall Street is forecasting a more realistic 0.2% growth rate in 2017 gross domestic product. Brazil’s economy is driven by resources and commodities. Its top commodity exports are oil, iron ore, soybeans, sugar cane and coffee.

While China is seeing its economy slowing, with GDP expected to post growth of 6.7% for 2016, that’s the kind of slowdown most country’s would kill for. Right now China is dealing with a cooling housing market, explosive growth in debt, and painful structural reforms instituted by President Xi Jinping.

“E-commerce is going well and that is tapping into a strong part of the economy,” said Rob Lutts, president and chief investment officer of Cabot Wealth Management, an RIA, in Salem, Mass. Lutts spends a lot of time traveling in China. “Investing in Alibaba is like investing in Amazon.com.”

Lutts said that China will have a big challenge over the next five years with a big debt bubble that will have to be distributed over the rest of the economy. This will bring the economic growth rate down to 5% by 2020. “They will have stress when the real estate bubble comes down in price, and that will hurt the smaller banks in the next six months.”

But Lutts is very bullish on India. For the fiscal year ended March 2016, India’s economy grew 7.9%, and Lutts said it could go higher. Indian Prime Minister Narendra Modi is instituting reforms to remove government obstacles to business and make the government more efficient. Lutts said his favorite way to invest in India is in the financial services sector.

He thinks HDFC Bank is one of the best-managed banks in the world. It’s also the top holding of iShares MSCI India ETF (INDA), No. 3 in WisdomTree India Earnings Fund (EPI), No. 2 in iShares India 50 ETF (INDY) and No. 3 in PowerShares India Portfolio (PIN). The ETFs’ year-to-date gains range from 8.8% to 9.8%.

Overall, all the experts think that because Europe is growing and Trump’s policies are still undefined, emerging markets should keep rising throughout the year.

Orginally published in Investor’s Business Daily.

Can China ETFs Continue Their Ascent?

China ETFs’ recent gyrations are enough to give one whiplash. Many have behaved like the Shanghai Composite Index recently. After soaring 152% over the previous 12 months — 60% this year alone — to a seven-year high on June 12, the benchmark for mainland China’s stock market hit a significant speed bump.

Last week the index stumbled 13% into a much-anticipated correction. A 5% rally the first three days of this week gave way to selling Thursday, cutting the week’s gain so far to 1%.

“The sheer increase in prices this year is something that makes me want to stand back,” said John Rutledge, chief investment strategist for Safanad, an investment house in New York. “I don’t know any fundamental reason why prices should have doubled this year, and that price behavior sounds like a bubble.”

Rutledge is referring to the fact that the Chinese economy’s growth rate has slowed to a six-year low of 7%. But if fundamental analysis can’t explain it, macroeconomics can. With central banks all over the world cutting interest rates, there is flood of liquidity looking for returns.

The first thing to know is that there are two markets in China. The Hong Kong market, which has long been open to global investors, trades what are known as H-shares. Then there are the mainland markets in Shanghai and Shenzhen. They trade A-shares, which had been limited to domestic investors.

But last year the Shanghai and Hong Kong markets created a system that let global investors buy A-shares and domestic investors buy H-shares. This change has brought a lot of money to the mainland markets.

On top of that, the People’s Bank of China, the country’s central bank, has cut interest rates three times since November, and more cuts are expected.

Finally, throw in a slowdown in the Chinese real estate market. It led the Chinese government to encourage investments in stocks by making it easier for Chinese retail investors to open accounts and buy stocks on margin.

Loss Of Liquidity

And a loss of liquidity sparked last week’s correction. First, Chinese regulators, worried that the market was getting overleveraged, tightened the rules on margin trading. Then a slew of initial public offerings sucked up a lot of cash.

There’s no doubt that China is risky. But gains could resume if the economy picks up and government stimulus programs continue. And index provider MSCI is evaluating A-shares for inclusion in its emerging markets index. That could spark demand by many funds that track MSCI indexes.

If you want China A-Shares in your portfolio, investing in ETFs is the way to go. KraneShares offers four ETFs focused on China. Its Bosera MSCI China A ETF (ARCA:KBA) holds more than 300 large-cap and midcap stocks on both the Shanghai and Shenzhen stock exchanges.

KraneShares says that these are the stocks that would be included in an MSCI emerging markets index. KBA is up 40% year to date and 126% in the past 12 months. It has an expense ratio of 0.85%.

Deutsche X-trackers Harvest CSI 300 China A-Shares ETF (ARCA:ASHR) tracks the CSI 300 Index, which holds the largest and most liquid stocks in the A-share market. It’s up 35% year to date and 129% for the past year. It charges 0.8% of assets for expenses.
Market Vectors ChinaAMC A-Share ETF (ARCA:PEK) also tracks the CSI 300 index but charges less: 0.72%. It’s up 39% year to date and 132% in the 12 months. The big difference is that ASHR is more liquid and offers a 0.2% yield, while PEK offers none.

As liquidity improves in July, David Goldman, managing director of investment firm Reorient Group, sees a market recovery and a move back up beyond the 5,000 level for the Shanghai Composite.

“Economic fundamentals are clearly improving, and so are regulatory incentives for stock market growth,” he wrote this week.

Originally published in Investor’s Business Daily.