Select Sector SPDRs Sue Over Shadow Symbols

The Select Sector SPDR Trust sued INVESCO PowerShares Capital Management over ticker symbols. Filed Thursday in U.S. District Court in Houston, the suit charges PowerShares with trademark infringement and misappropriation.

Select Sector SPDRs offers a family of ETFs that divides the S&P 500 into nine individual sector funds. In April, PowerShares launched a family of nine sector ETFS for the small-cap market based on the S&P 600, a small-cap index. (Blog Postings: Small-Cap Investors Get Sector Funds and Sector ETFs Help You Avoid Single-Stock Risk)

The PowerShares funds, which trade on the Nasdaq Stock Market, use four-letter ticker symbols that add an “S” to the end of the ticker for the Select Sector SPDR funds covering the same industry. Those trade on the NYSE Arca.

“This is a deliberate and unconscionable act on the part of PowerShares to confuse both institutional and retail investors,” said Dan Dolan, director of wealth management strategies for the Select Sector SPDR Trust in a written statement. “PowerShares has succeeded in casting an unfortunate shadow on Wall Street’s efforts to eliminate financial opacity.”

Dolan noted that 101 out of 102 ETFs previously launched by PowerShares have tickers that start with “P.” The sector funds in question are the only products in PowerShares ETF family that begin with an “X.”

Below is a list of the funds side-by-side:

Sector SPDR Consumer Discretionary (XLY)
PowerShares S&P SmallCap Consumer Discretionary Portfolio (XLYS)

Sector SPDR Consumer Staples (XLP)
PowerShares S&P SmallCap Consumer Staples Portfolio (XLPS)

Sector SPDR Energy (XLE)
PowerShares S&P SmallCap Energy Portfolio (XLES)

Sector SPDR Financials (XLF)
PowerShares S&P SmallCap Financials Portfolio (XLFS)

Sector SPDR Health Care (XLV)
PowerShares S&P SmallCap Health Care Portfolio (XLVS)

Sector SPDR Industrials (XLI)
PowerShares S&P SmallCap Industrials Portfolio (XLIS)

Sector SPDR Materials (XLB)
PowerShares S&P SmallCap Materials Portfolio (XLBS)

Sector SPDR Technology (XLK)
PowerShares S&P SmallCap Information Technology Portfolio (XLKS)

Sector SPDR Utilities (XLU)
PowerShares S&P SmallCap Utilities Portfolio (XLUS)

Calling the PowerShares symbols “astoundingly similar,” Dolan told the Wall Street Journal: “I don’t think there’s any other way of looking at it than they’re trying to jump on our back.”

He’s right, of course. If PowerShares planned to latch onto this already understood product, it was a brilliant marketing strategy. The Select Sector SPDRs are probably the most recognizable ETFs in the world. Their marketing campaign of spiders making webs in the shapes of industry icons, such as an oil rig for its energy ETF or a stethoscope for the health care ETF, has been a huge success, both in explaining that ETFs are financial products and what a select sector is. Traders, large and small, call stocks by their tickers not their company names. So, if you wanted the small-cap fund for energy, instead of XLE, you would simply remember the “S” for small.

The question becomes who owns a ticker symbol and can you trademark the first two or three letters of a ticker symbol? Currently, the Intermarket Symbols Reservation Authority, run by the Options Clearing Corp., or OCC, assigns ticker symbols to companies and ETFs. “The ISRA operates a uniform, transparent system for the selection, reservation, assignment and transfer of securities trading symbols by NMS Plan participants.”

Since there are only so many possibilities for three- and four-letter combinations, aren’t there always going to be tickers similar to yours? For instance, most people assume INTL is the ticker for Intel, but it’s not; it’s INTC. Surprisingly, among the many media outlets that reported this story, no one seems to have called the OCC for its opinion.

I did, but the OCC hasn’t gotten back to me.

Meanwhile, I would say the amount of market confusion is minimal. The Journal says the nine Select Sector SPDRS have $31 billion in assets under management. Meanwhile, the nine PowerShares funds in question hold only $50 million. Most hold less than $6 million, and have an average daily trading volume of less than 10,000 shares a day. The Select Sector SPDRS see average daily volumes in the tens of millions.

Advertisement

Small-Cap Investors Get Sector Funds

One of the great things about ETFs is their ability to create tactical asset allocations with precision. Tactical asset allocation is an active portfolio strategy in which the investment manager accentuates certain categories of assets beyond the basic allocation in order to take advantage of exceptionally strong market sectors or pricing anomalies. After the manager makes some profits and the advantageous situation has run its course, she returns the portfolio back to its original strategic mix.

The most popular way to make a sector play with ETFs has been to purchase one of the nine funds known as the Select Sector SPDRs. These funds allow investors to hedge sector-specific risk within concentrated stock positions, add sector-specific beta to a portfolio without any stock-specific conviction, overweight or underweight specific sectors, and manage investment transitions.

For example, you could have 70% stocks and 30% bonds. Then you break down stocks into smaller allocations, such as 30% large-caps, 20% mid-caps, then 20% small-caps. If you wanted to focus on large-cap energy and financials, you could split the large-cap allocation with 10% in an energy ETF, 10% in a financial ETF and 10% in the S&P 500.

The Select Sector SPDRs break down the S&P 500 into nine industry groups. However, all these funds are filled with large-cap stocks. In fact, most sector ETFs are filled with large-cap stocks. With only 18 out of the 8,500 mutual funds and ETFs on the market categorized as small-cap sector funds, small-cap investors looking for tactical sector allocation have been at a severe disadvantage.

Invesco PowerShares remedied that last Wednesday by launching on the Nasdaq the first suite of ETFs offering sector-specific beta exposure to U.S. small-cap equities.

PowerShares S&P SmallCap Consumer Discretionary Portfolio (XLYS)
PowerShares S&P SmallCap Consumer Staples Portfolio (XLPS)
PowerShares S&P SmallCap Energy Portfolio (XLES)
PowerShares S&P SmallCap Financials Portfolio (XLFS)
PowerShares S&P SmallCap Health Care Portfolio (XLVS)
PowerShares S&P SmallCap Industrials Portfolio (XLIS)
PowerShares S&P SmallCap Information Technology Portfolio (XLKS)
PowerShares S&P SmallCap Materials Portfolio (XLBS)
PowerShares S&P SmallCap Utilities Portfolio (XLUS)

The new ETFs charge an expense ratio of 0.29% compared with the expense ratios of 0.49% for the average small-cap ETF and 0.57% for the average sector-specific ETF. The average sector-specific mutual fund charges an average of 1.75%.

With each of the nine portfolios a subset of the S&P SmallCap 600 Index, the new suite is obviously a direct copy of the Select Sector SPDRS adapted for small-caps. So much so, the new ETFs have the same ticker symbol as their large-cap counterparts with an “S” added on. And why not? The Select SPDRs are some of the most popular ETFs around with $33.75 billion in assets among the nine funds. Of course, they’ve been around for 11 years.

In fact, the idea is so obvious, it’s a wonder it hasn’t been done before. But now it seems even more important.

“Over the long term, small-cap companies have outperformed large caps with much of this outperformance occurring during post-recessionary periods,” said Ben Fulton, Invesco PowerShares managing director of global ETFs.

According to Morningstar/Ibbotson, as of March, in the 36 months following each of the last 15 recessions, small-caps outperformed large-caps by an annualized average of 5.6%. This post-recession performance has contributed to their outperformance of large-cap stocks by more than 200 basis points a year since 1926 and more than 400 basis points a year since 1975.

Over the past 10 years if you held a fund with the entire S&P 500, you’d be pretty much flat for your return. During that time, Bloomberg says each small-cap sector outperformed its large-cap counterpart. So why pick the S&P SmallCap 600 Index instead of the small-cap market benchmark the Russell 2000?

I think it’s because all the members of the Small-Cap 600 have been specifically chosen and must have posted four consecutive profitable quarters. The Russell 2000 are strictly picked based on market cap and can be unprofitable. In addition to being financially viable, to qualify as a small-cap a stock must meet the following criteria:

· They must have a market capitalization between $250 million and $1.2 billion
· They must have annual trading volume of at least 100% of its market cap
· At least 50% of its shares must be publicly available.

S&P SmallCap 600 Index is a float-adjusted, market-capitalization-weighted index reflecting