All I Wanna Do Is Have Some Fun

Is Sheryl Crow to blame for the NETS’ demise?

In the first major ETF consolidation of the year, last week, Northern Trust officially liquidated all 17 members of its ETF family, the Northern Exchange-Traded Shares, or NETS. Simultaneously, the bank spent millions of dollars to sponsor a PGA tournament, the Northern Trust Open at the Riviera Country Club, and throw lavish star-studded parties around Los Angeles.

The Chicago bank paid to fly hundreds of clients and employees to the tournament, paid for their rooms at some of the city’s priciest hotels — the Beverly Wilshire, the Ritz Carlton and the Casa Del Mar — and shuttled its guests to the tournament in Mercedes.

According to L.A. gossip site TMZ.com, Wednesday, Northern Trust hosted a dinner with entertainment from the band Chicago. Thursday, dinner was held at a private hangar at the Santa Monica Airport followed by a concert from Earth Wind & Fire. Friday, the NETS were officially shut down. Saturday, Northern Trust took over the House of Blues, served salmon and filet mignon, and had Sheryl Crow serenade its guests. Female guests left with gift bags from Tiffany’s.

TMZ said Northern Trust paid Chicago $100,000 and the House of Blues $50,000. The other two bands declined to disclose their fees. Northern Trust also footed the bill for the entire tournament and part of the $6.3 million purse.

In light of the fact that Northern Trust took $1.6 billion from the government’s Troubled Asset Relief Program, or TARP, there’s plenty of outrage over this egregious display of wasteful spending, especially since Northern Trust laid off 4% of its workforce in December. But putting that aside, couldn’t this money have been used to save the NETS?

It takes between $250,000 and $650,000 to bring an ETF to the market. Let’s say $500,000 each, or $8.5 million, to launch 17 funds. Then assume another $500,000 in annual expenses to run the funds, or another $8.5 million a year to keep the NETS operation afloat. While we don’t have a total cost for the party, from the TMZ data, it’s not hard to imagine the whole thing costing around $8.5 million, essentially what it costs to keep the ETFs afloat for another year.

Is the death of an ETF or an ETF company worth mourning? In the grand scheme of things, probably not. Definitely not by its competitors, but the ETF industry is still small, with just about 25 companies. So, less competition and fewer good ideas are bad for investors and the industry in general.

Of course, the ETF industry did go through a huge growth spurt from 2006 to 2008 as companies in a gold-rush-type spirit pushed out funds based on any idea that came into their heads. There were some great ideas, such as the commodity- and currency-based exchange-traded vehicles, and some incredibly stupid ones. Amidst a falling stock market and declining economy, investors are less willing to take a risk on an offbeat idea. So, consolidation of the industry was not unexpected. In some cases, that’s a good thing.

Among the stupid ideas we’re well rid off, let me point you to the Focus Shares. As the housing bubble popped these geniuses came out with the ISE Homebuilders Index Fund. Their other brilliant ideas were the ISE-CCM Homeland Security Index Fund, which tracked companies that did work for the Department of Homeland Security, and the ISE-REVERE Wal-Mart Supplier Index, which followed companies that derive a large portion of their revenues from sales to Wal-Mart.

Others like the HealthShares or the Claymore/KLD Sudan Free Large-Cap Core Fund were clever portfolio ideas, but much too narrowly focused to attract a large audience, especially in times such as these.

But the NETS were different. They offered investors the first way to invest in the world’s main global stock indexes. Instead of investing in a little known MSCI index of a foreign market, the NETS gave investors the opportunity to invest in a country’s actual benchmark. The NETS tracked London’s FTSE-100, Germany’s DAX Index and France’s CAC-40 Index, among others. The NETS were also the first to offer U.S. investors exposure to the Irish, Israeli and Portuguese markets. Also, they were run by Steven Schoenfeld, the man who wrote the book on indexing. In addition to being an indexing expert, Schoenfeld helped build the iShares business in its early days.

The NETS were reported to have $33 million in assets under management and charged an expense ratio of 0.47%, bringing in $155,100 a year. So, they weren’t paying their way, but it doesn’t cost that much to keep them going. These were young funds that needed to find an audience. So, it seems shocking that after all the time and effort to bring an ETF to market, a firm would give up on them so fast? In a down market, investors aren’t in the mood to invest, but you want to have products ready and available the moment investors come back.

While the ETF industry experienced a record number of fund closings in 2008, most of those came out of independent ETF shops. However, Northern Trust is a huge Chicago-based investment bank. According to Barron’s Dimitra Defotis, while the nation’s prominent banks are suffering and asking for money from the U.S. government, Northern Trust has a far more promising outlook.

“Unless you think the world is going to disappear in the next five years, our position as the leading wealth manager in the United States should serve us well as the U.S. market recovers,” CEO Frederick H. Waddell told Barron’s “On the institutional side, we continue to win significant asset-management and servicing mandates around the world.”

Barron’s says Northern Trust’s balance sheet is better than most other banks, because it avoided housing finance. In addition, it’s gaining customers from overseas institutions. Finally, it’s fee income, which accounts for more than half its revenue, came in at $4.2 billion last year.

So, with about $8 billion in revenues and $1.6 billion of TARP money, it seems incredibly short sighted for Northern Trust to have closed down the ETFs. And after spending about $8.5 million for a golf tournament and parties, it really wasn’t a lot to keep them open. In fact, this wasteful spending of government money for bonuses and parties shows how this isn’t just obnoxious, but actually detrimental to these banks and their customers. It is truly taking cash out of the funds necessary to run these banks’ operations. Businesses are being shut down so top managers can party. It’s nauseating.

I think the NETS were good products and I’m sorry to see them go. Since these ETFs were based on a good idea, I’m sure some other company will create similar products. Still, while the Northern Trust head honchos sang, “All I Wanna Do is Have Some Fun”, the ETF industry and investors are singing another Sheryl Crow hit: “The First Cut is the Deepest.”

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Court Dismisses XShares Lawsuit

Jeffrey Feldman and the rest of the XShares executive suite caught a break.

The Supreme Court of New York dismissed the lawsuit XShares Group, the ETF firm he founded, filed against Feldman, his former partner Anthony Dudzinski, its former and current chief executive officers, and seven other company managers or officers.

In a story first reported on this blog, Donald Aven, a former executive vice president of national sales for the XShares Group, the parent company of XShares Advisors, the ETF sponsor; and his brother, Samuel Aven, an investor in the company; filed the suit in August. They alleged that the 11 defendants committed breach of fiduciary duty, breach of loyalty duty, theft of business opportunity, fraud, and other actions that enriched the officers to the detriment of the company.

According to a written statement XShares released Tuesday, Supreme Court Justice Charles E. Ramos stated on Nov. 25 that no proper amended complaint had been put before the court. Judge Ramos also found that the caption was incorrect in naming XShares Group, as the plaintiff instead of the Avens’ as plaintiffs individually and on behalf of the company, said XShares. As a result, the court ordered that the caption be changed accordingly and that the action be dismissed outright,

“We are pleased with the Court’s decision,” said Feldman, founder and chief strategist at XShares, in a written statement.

And why wouldn’t he be. It’s the first good news the firm has had all year.

One should note, the lawsuit wasn’t dismissed for lack of cause, but rather on a technicality. Still, it’s an early Christmas present for a firm that hasn’t had much to cheer about this year.

Just a few weeks ago, the firm closed the four remaining HealthShares ETFs that had been the firm’s flagship product. Launched in January 2007 with 19 ETFs tracking narrow niches of the health care industry, HealthShares was XShares first family of ETFs. Earlier this summer, XShares also closed down its family of ETFs that tracked the real estate market.

XShares continues to manage the TDAX lifecycle ETFs for TD Ameritrade. These funds are currently outperforming the S&P 500 according to a TD Ameritrade spokesperson.

Xshares to Liquidate Last Four HealthShares

XShares Advisors announced on Wednesday that it plans to liquidate the four remaining HealthShares ETFs at the end of the year and subsequently dissolve the HealthShares registered investment company.

The four ETFs are the HealthShares Cancer Exchange Traded Fund (HHK), HealthShares European Drugs ETF (HRJ), HealthShares Diagnostics ETF (HHD), HealthShares Drug Discovery Tools ETF.(HHV).

The funds’ board of directors decided to take the action in light of the current market conditions. Since their inception the HealthShares funds had been unable to attract significant market interest. Launched in January 2007 as a family of 19 funds, HealthShares offered portfolios that tracked extremely narrow, highly specialized areas of the health-care industry, such as cardiology, orthopedics and dermatology.

In August, with only a total of $100 million in assets under management, Xshares, the investment advisor to the fund, closed 15 of the 19 ETFs. The four remaining funds held about half the total assets. Then in October, the benchmark indexes for the surviving four were redesigned to hold between 28 and 35 stocks, up from the 22 with which they originally launched. All four also lowered their expense ratios to 0.60%, except for European Drugs, which charged 0.72%. This move came on the heels of Xshares closing its AdelanteShares family of seven real estate ETFs in June. In their nine months of existence they accumulated only $17 million of assets under management. Also in June, Xshares sued its chairman, founders, current and former CEOs and others for fraud and other charges.

The HealthShares board on Wednesday said the funds’ future viability and prospects for growth in assets in the foreseeable future were not encouraging. Thus, the board determined that it was in the best interests of the funds and their shareholders to liquidate
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“We continue to believe in the fundamentals of the healthcare industry. Unfortunately under these tough market conditions, the Funds were unable to achieve meaningful investor traction,” said Joseph L. Schocken, chairman and chief executive officer of XShares Group, parent company of Xshares, in a written statement. “We remain strongly committed to bringing our products now under review to market. In 2009, we expect to launch additional products related to the environment and infrastructure.”

The TDAX series of lifecycle ETFs that XShares launched in partnership with TD Ameritrade continue to trade.

The HealthShares last day of trading on the NYSE Arca and the last day share may be purchased or redeemed will be Dec. 23. Trading will halt before the open Dec. 24. From Dec. 24, through Dec. 31, shareholders may sell their Shares to certain broker-dealers who may determine to continue to purchase such shares, but there can be no assurance that any broker-dealer will be willing to purchase the shares or that there will be a market for the shares. All shareholders remaining on Dec. 31, 2008 will receive cash equal to the amount of the net asset value of their shares that day.

For additional information about the liquidation, shareholders may call XShares at 1-800-925-2870.

XShares Sues Founders, CEOs and Managers

XShares Group, the ETF sponsor of the HealthShares family of ETFs, filed a lawsuit against its own founders, Jeffrey Feldman and Anthony Dudzinski, its former and current chief executive officers, and seven other company managers or officers, alleging actions that enriched the officers to the detriment of the company.

According to a filing with the Supreme Court of New York state Donald Aven, XShares executive vice president of national sales, and Samuel Aven, charged the 11 defendants with breach of fiduciary duty, breach of loyalty duty, theft of business opportunity, corporate mismanagement, misappropriation of corporate assets, self-dealing, and fraud.

The lawsuit lists a series of charges:

• That former CEO William Henson and current interim CEO Joseph Schocken received bonuses and other compensation that represented a conflict of interest with XShares
• That the defendants diverted a corporate opportunity by allowing investor Grail Partners to misappropriate XShares business model.
• That the company failed to meet capital and regulatory requirements by not maintaining separate books and records for XShares and its subsidiaries.
• That the directors failed to provide adequate or not misleading disclosures to investors.
• That the defendants failed to secure proper legal opinions for corporate actions.
• That the defendants allowed the payment of excessive compensation to the officers.
• That the defendants provided liquidation and other preference to third party investors to the detriment of XShares.

Representatives for XShares declined to comment on the lawsuit.

It’s been a rough year for the small ETF sponsor. At the end of the first quarter, after just five months on the job, CEO Henson left the firm for an unexplained leave of absence. Then in July, Dudzinski unexpectedly left “to pursue some other opportunities.” He had served as president and board member of XShares Group, the parent company, and as chief executive officer of XShares Advisors, the ETF provider. Around the same time the firm cut a large part of its sales staff.

The turmoil in the executive suite was mirrored on the product line. The firm closed its AdelanteShares family of seven real estate ETFs in June. In their nine months of existence they accumulated only $17 million of assets under management. Then in August, the firm’s flagship ETF family, the HealthShares, underwent a major overhaul. XShares closed 15 of the 19 ETFs focuses on highly specialized areas of the health-care industry. At the time of the reorganization, the 19 HealthShares held a total of $100 million in assets under management, with about half of that in the four surviving funds.

The four remaining ETFs:

• HealthShares Cancer Exchange Traded Fund (HHK)
• HealthShares European Drugs ETF (HRJ)
• HealthShares Diagnostics ETF (HHD)
• HealthShares Enabling Technologies ETF (HHV), which will be renamed HealthShares Drug Discovery Tools ETF.

In October, the benchmark indexes for all four were redesigned to hold between 28 and 35 stocks, up from the 22 with which they originally launched. All four also lowered their expense ratios to 0.60%, except for European Drugs, which charges 0.72%. The TDAX series of lifecycle ETFs that XShares launched in partnership with TD Ameritrade continue to trade.

 

Dudzinski Out at Xshares

Anthony Dudzinski is out at XShares, the exchange-traded fund provider he co-founded in 2006.

Dudzinski left his positions as chief executive officer of XShares Advisors, the ETF provider, and as president and board member of XShares Group, the parent company, on July 15. XShares also laid off a large part of its sales staff around the same time.

“I have decided to pursue some other opportunities,” said Dudzinski. “While no longer an employee, I have signed a consulting agreement to help them implement their business plans. I have a long-term interest in their success. This new relationship allows me to do a lot of different things.”

He said he would continue to bring in new clients who would like to get into the ETF marketplace.

XShares is best known for the HealthShares ETF family, a group of funds that sliced and diced the health care industry into 19 specialized categories, such as cardiology, cancer, dermatology and orthopedic repair.

Dudzinski’s departure marks a low point in a tumultuous year for the small New York firm. At the end of the first quarter, William Henson, the parent company’s CEO, left for an extended leave of absence. A member of Grail Partners (itself an early investor in XShares), Henson lasted less than five months on the job with XShares. The reason for his departure was never given.

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