Study: Self-Directed Investors Use ETFs 20% More than Advised Investors

Cogent Research, a research firm I’ve never heard of, agrees with the assessment Bruce Bond, the CEO of PowerShares, made on this blog last week.

“We think that what is happening in the broader market has truncated the adoption of the ETF among the investment professional community,” said Bond.

Cogent says self-directed investors are playing an increasingly significant role in defining the ETF product landscape. In ETF Investor Brandscape, a recently published national study of 4,000 affluent Americans, the firm says “interest, usage and commitment to ETFs is significantly higher among self-directed investors who manage their own portfolios.”

According to Cogent, these are the study’s major findings:

* Self-directed investors’ awareness of several top ETF providers is almost twice that of advised investors.

* Equal proportions of self-directed and advised investors use ETFs, however, self-directed investors allocate 20% more of their portfolio to ETFs (The actual numbers were 17% average allocation to ETFs among self-directed vs. 14.1% average allocation to ETFs among advised).

* Among current ETF owners, self-directed investors are far more loyal to their primary ETF provider than are investors who purchase and own their investments through an advisor.

* Usage of ETFs is expected to increase significantly in 2009 among current owners and non-owners alike. On average, one out of every four (25%) current ETF owners plans to increase their ETF holdings. Among self-directed investors, the proportion of likely increased use rises to 35%, representing a 40% higher increased adoption rate.

* iShares and Vanguard are fighting for the number one spot in overall customer experience, which will payoff in loyalty and increased investments. Meanwhile, PowerShares, State Street Global Advisors, and ProShares must work harder to inspire existing clients to increase investments. Furthermore, challenger brands like WisdomTree and Rydex need to focus on the basics–increasing investor awareness of their offerings.

“Everything we see in the data suggests that there is real ‘home-grown’ passion among investors–both advised and self-directed–for ETFs,” says Christy White, founder and principal of Cogent Research in a written statement. “Providers that are committed to promoting and supporting a dual distribution strategy will prevail in this growing marketplace.”

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Got Them By The Shorts

Barron’s recently examined how the double-leveraged and double-inverse leveraged ETFs out of ProShares, Rydex and Direxion can create startling and distressing results for investors who correctly pick the direction of the market.

In the four months following the end of the Beijing Olympics, the Chinese stock market plunged 34%. Investors who bought the ProShares UltraShort FTSE/Xinhua China (FXP) right after Olympics and held on expected to see a return of 68%. Instead they received a 56% loss.

The devil is in the details. The leveraged funds only guarantee double the return on a daily basis. So, if the fund falls 20% one day and rises 20% the next, the investor isn’t even. That’s because the initial base on the second day is only 80% of the first day’s total. The Barron’s piece, One-Day Wonder, gives a good simple explanation. For more details on how this works, check out Chapter 9 of ETFs for the Long Run.

Stepping on the brakes

Much like other structured products that came of age during the past decade, the market crash of 2008 was the first serious test of how exchange-traded funds would react in a bear market. But while the surge in issuance has continued in Europe and Asia, growth rates in the US have slowed.

The exchange-traded funds (ETFs) industry outside the US has surged this year, with 253 funds launched by the end of September, a 69% increase on the same period last year and a figure that is already 27% bigger than all ETF issuance in 2007. During the two months to September 30 – one of the worst periods in recent stock market history – 83 ETFs were launched bringing the total to 1,499 funds on 43 exchanges worldwide, while assets under management hit $764.08 billion. Barclays Global Investors expects this figure …

This was originally published in Structured Products. For the full article click here.

ETFs See Cash Inflows Even as Asset Values Fall

ETFs and ETNs continue to see net cash inflows even as total assets under management fall. The conclusion is this is a function of just falling asset values.

According to the National Stock Exchange (NSX), at the end of November, total U.S. listed ETF and ETN assets fell 16.8% to $487.6 billion from $585.8 billion in November 2007. However, net cash inflows for the month were $26.4 billion, bringing the total net cash flow for the 11 months through Nov. 30 to $136.8 billion. In November, 315 ETFs saw net cash inflows, while 179 saw outflows. ETNs split at 16 each.

Notional trading volume in both ETFs and ETNs fell 33% in November from October to $2.2 trillion. Surprisingly, this represents a record 43% of all U.S. equity trading volume, up from 38% in October. That just shows how much total equity volume must have fallen off. At the end of November 2008, the number of listed products totaled 843, compared with 650 listed products one year ago and 806 in October.
According to the NSX, the only ETF firms that saw assets grow are State Street Global Advisers, ProShares, Van Eck and

Ameristock/Victoria Bay. All those firms saw net cash inflows for the year through Nov. 30 increase compared with the first 11 months of 2007. Vanguard did as well. ProShares’s assets under management rocketed 112% to $20.9 billion. SSGA’s assets grew 8.3% to $142.9 billion. This really shouldn’t be a surprise. ProShares sponsors the inverse and leveraged ETFs that have proved hugely popular in the market turmoil. SSGA sells the largest, most liquid ETF, the SPDR (SPY), which tracks the S&P 500. Many investors making a flight to safety or seeking a place to hold cash on a temporary basis will move to the S&P 500. Even as the S&P 500 sinks, the SPDR’s 2008 net cash inflows have surged 86% year-over-year through Nov. 30 to $18.23 billion.

Meanwhile, BGI’s iShares saw assets tumbled 29% to $229.3 billion.

Firms with net cash outflows in November included PowerShares, $309 million, and Merrill Lynch’s HOLDRs, which saw redemptions of $889 million. Surprisingly, the HOLDRs saw net cash outflows of $3.6 billion in 2007, but are up $1.2 billion so far this year. Other firms that experienced outflows in November were WisdomTree, FirstTrust, and SPA-ETF. Firms with net outflows year-to-date include Bank of New York, Rydex, X-Shares, Ziegler, FocusShares and BearStearns. The last two have gone out of business this year. Rydex is suffering as the strengthening dollar hurts its CurrencyShares.

As for ETNs, Barclay’s iPath family saw assets plunge 36% to $2.6 billion. In November, iPath saw outflows of $39 million. Morgan Stanley/Van Eck ETNs recorded outflows of $16 million in November. Meanwhile, Goldman Sach’s ETNs net cash outflows grew to $97 million year-to-date. Comparisons are not relevant for many of the other ETN firms as they had few funds, if any, last year.

Among the top ten ETFs and ETNs, the SPDR (SPY), iShares MSCI EAFE Index Fund (EFA), SPDR Equity Gold (GLD), iShares S&P 500 Index Fund (IVV), iShares Russell 1000 Growth Index Fund (IWF) and iShares Russell 2000 Index Fund (IWM) all saw net cash inflows in November, according the NSX. Of the 10 largest funds, these saw outflows last month: iShares MSCI Emerging Markets Index Fund (EEM), PowerShares QQQ (QQQQ), iShares Barclays Aggregate Bond Fund (AGG) and the Dow Diamonds (DIA).

The NYSE Group also releases volume data for its exchanges. Average daily matched volume for ETFs, or the total number of shares of ETFs executed on the entire NYSE Group’s exchanges surged 93.5% to 672 million shares from 347 million shares in November 2007. Total matched volume for the month totaled 12,765 million shares, a 75.1% increase. Total volume year-to-date through Nov. 30 jumped 74.7% from the same period last year to 102,583 million shares.

Handled volume, which represents the total number of shares of equity securities and ETFs internally matched on the NYSE Group’s exchanges or routed to and executed at an external market center, totaled 14,813 million shares last month, a 77.6% surge over the year-ago month. Average daily handled volume rocketed 96.3% to 780 million shares from 397 million shares a year ago. Year-to-date total volume climbed 78.1% to 117,629 million shares.

The NYSE also reported total ETF consolidated volume for the month leapt 92.1% to 45,151 million shares, while total average daily volume soared 112.3% to 2,376 million shares. Year-to-date, total consolidated ETF volume surged 119.4% over the first 11 months of 2007 to 355,133 million shares. I think those refer just to the NYSE Group.

Talking About ProShare on the Radio Again

I guess my October appearance on The Vince Rowe Show, the Online Trading Academy, was a success.

I’m talking on the radio again about ProShares and short ETFs today, Thursday, at noon, eastern time. I will also talk about Rydex and the new Direxion short ETFs.

You can listen live online at Vince Rowe.com, on Live360, or on the BizRadio Network.com.

Or on these radio stations:
BizRadio Network 1110AM Dallas: 11:00 am – 12:00 pm Monday – Friday
BizRadio Network 1110AM Houston: 11:00 am – 12:00 pm Monday – Friday
CNN Radio 1190 Dallas: 12:00 pm – 1:00 pm Monday – Friday

Not Nyet, Barney Ruble

ETF firms have had a rough time over the past year. Launching new products during a major market meltdown is problematic. Investors watching their investments plunge in value are hardly looking for new products to invest in. Innovative products all around have been smeared with the scandal and dirt coming off of derivatives such as credit default swaps. And if investors are looking at ETFs, they are moving toward more conservative investments. They aren’t necessarily willing to take a risk on some new index of an obscure sector or other out-of-the-box ideas.

So, it’s into this atmosphere that Rydex Investments launched the latest in its CurrencyShares family of exchange-traded products, or ETPs. On Thursday, Rydex’s CurrencyShares SM Russian Ruble Trust (XRU) began trading on the NYSE Arca. This new ETP is the first to offer time currency exposure to the Russian economy by tracking the daily price movement of Russia’s currency, the ruble, in U.S. dollars.

It couldn’t have come at a worse time. The ruble has been in a sharp decline as the Russian stock market and economy enter a freefall coinciding with the plunge in oil prices. The day before the ETP launched, Russia’s central bank spent $2 billion to defend the currency. According to the Wall Street Journal, on Tuesday, the Russian central bank “widened its target band for the currency’s rate against a dollar/euro basket by about 1% in each direction. Investors quickly pushed the ruble to the lower limit.” This move reversed “weeks of rigid defense that fueled a $112 billion decline in reserves since the summer.” Then on Thursday, Russia’s two chief stock exchanges were shut down after stock prices plummeted.
WSJ quoted Renaissance Capital economist Alexei Moiseyev saying, “Today’s move achieves nothing.” The modest decline in the ruble “has only served to raise market expectations of a further devaluation.” While industry leaders want to let the ruble weaken further to lower the cost of Russian exports, while increasing the prices of imports, government officials rule out a sharp devaluation. Such a move could send the nation into a panic.
The eight CurrencyShares ETPs track the euro, Australian dollar, British pound, Canadian dollar, Japanese yen, Mexican peso, Swedish krona and Swiss franc. They are pure plays against one currency, and they trade like a regular ETF, with shares on a stock exchange. This is a big improvement over investing in the forex market. That popularity can be seen in the approximately $2.2 billion in assets under management they have acquired. This is 45% of the industry’s total currency ETP assets, according to Citigroup Global Markets’ Oct. 31 ETF Flow Report.

Over the past three years, the CurrencyShares have been a very popular way for investors to profit on the falling U.S. dollar. But with the dollar’s recent rise, suddenly, it’s not such an easy trade. Of course, Rydex couldn’t have predicted oil prices would plunge when it filed to register this ETP with the SEC more than six months ago. Still, the mantra among ETF companies is that there is a demand for these products because investors are requesting these funds. It might be time to stop listening to these investors.

Where Does Short Ban Leave Short ETFs?

Where does the short-selling ban leave the ETFs that short the financial markets?

ProShares Financial ETFs resumed trading just around noon, after a two-hour halt in the shares of both the Short Financials ProShares (SEF) and UltraShort Financials ProShares (SKF). At 9:33 a.m., the American Stock Exchange halted trading in the UltraShort ETF after it tumbled $22.44, or 19.4%, to $93 and the Short ETF fell $5, or 8%, to $66. Trading in both resumed about 11:40 a.m.

The sharp decline was a direct result of the Security and Exchange Commission’s early Friday ban on the short selling of financial stocks. Short selling is when investors sell shares first in the expectation that they can buy them back later at a lower price. The ban prevents the shorting of 799 financial stocks. CNBC later reported that General Electric and CIT might be added to the list.

The ProShares ETFs give investors the opportunity to short the financial sector in one trade through a long instrument, or as the company says, buying long to go short. The Short ETF gives the inverse return of the Dow Jones U.S. Financials Index and the UltraShort tries to give investors double the negative return on a daily basis.

It appears the halt was caused by ProShares refusal to create new shares. After trading resumed ProShares released a statement saying because of the SEC ban on short selling it did not “expect to accept orders from Authorized Participants to create shares until further notice.” Shares will continue to be redeemed. However, the company added that these shares “may trade at prices that are not in line with their intraday indicative values.”

Ironically, the ProShares ETFs should be a great way for market players to short the financial markets in the wake of the SEC ban, but the halt and the decision, or inability, to issue more creation units throws this into doubt.

ETFs are like mutual funds in that they are both open-end investment companies. They create shares when demand increases and they redeem shares when demand drops. The difference is the mutual fund sells its shares directly to individual investors, but ETFs only sell shares to brokers, dealers and market specialists called Authorized Participants, or APs. The specialist needs to buy all the shares in the index, then trades them with the ETF for an equal number of ETF shares. This is called the “creation unit”. The trade is called the “in-kind trade,” because it’s shares for shares. The AP then sells the ETF shares on the stock market to investors like you and I. If there’s more investor demand for shares of an ETF, the AP will buy the stocks to trade for more ETF shares, then sell the new shares into the secondary market in the hopes of making a profit.

However, ProShares short funds don’t hold the stocks or short the stocks in the indexes they track. They hold futures contracts that short the indexes and swap agreements. Swaps are contracts between two parties, in this case the ETF provider and a counter party, to exchange a revenue stream. According to ProShares May 13 annual report, the UltraShort ETF held swap agreements equally 200% of its net assets.

Bob Pisani on CNBC said early this morning that with the short restrictions it’s harder for the counter parties to satisfy their obligations. “With restrictions on the short side, firms either cannot provide the swaps or the price of providing them has increased dramatically because dealers who sell the swaps hedge by shorting.” Pisani added that there are now fewer counter parties available. He said there were just four.

As of May, those four were Bank of America, Credit Suisse, J.P. Morgan Chase and UBS Warburg and Lehman Brothers. But Lehman went bankrupt on Monday and its demise left ProShares scrambling to find someone to take on those swaps.

So, if the cost of the swaps goes way up, the only way to hedge is to charge far more for the hedge option. This could significantly increase the costs on these funds, which already charge the extremely high expense ratio of 0.95% annually.

IndexUniverse reported an interesting tidbit. It said the Rydex 2X Inverse Select Sector SPDR Financials (RFN) ETF, which also gives a negative 200% return, traded even as the ProShares ETFs were halted. Rydex said its creation/redemption mechanism continued to function normally. IndexUniverse attributed this to RFN using mostly options to gain exposure to the financial market instead of swaps. Historically, swaps have given investors a more efficient way to track the market, but the deleveraging of swaps has been a large component of what is gone wrong with the financial markets this week. And the short-selling ban has only exacerbated that. Meanwhile, the options market continues to function normally.

So, where does that leave the ETFs that short the market? Will they give short sellers the necessary outlet they need to short the markets? Doubtful, because in the end, the funds try to give investors the return of the index. And the index won’t fall much if the component stocks don’t fall much. And the components won’t fall much because, well, they can’t be shorted. However, this shorting ban puts an artifical floor on the financial sector, and the broader market in general.

The first question to ask is can this ban become permanent. Doubtful. There are too many institutional investors that rely on shorting and this essentially removes from them a significant way to hedge their positions. So, if the ban will be removed, what happens when the SEC removes it? Obviously, it’s a big unknown, but if the values are not there and today’s rally is on false pretenses, the shorts could come back and put significant pressure on the market. And when one considers how this came about with no warning and totally screwed all the short sellers, they will be out for revenge. Cold blooded revenge. And you may see the worst market decline since 1929. If that happens. These next two weeks may give investors a nice opportunity to pick up the SEF, SKF and RFN at a low price amid low volatility and just wait for floodgates to open. Geronimo!