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Q. What is the next evolutionary phase that you see in CEFs and ETFs?
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A. As for CEFs, I think they will continue the pattern they traditionally follow, namely capitalizing on fixed-income opportunities in the bond market and less frequently on opportunities in the equity market. The large bulk of CEFs launched in the last year have been fixed-income funds. These take advantage of trends in the market and the rising interest rate environment and investor concern over inflation.
But we are also seeing some new innovations. If we look at the SEC Filings, for example, we see a fund that plans to issue covered calls which is a new development in the CEF world. More recently there has been a filing for an index fund. Depending on the successes of these two new innovative types of closed end funds we could see more CEFs designed to protect investors from fluctuations in the market.
As far as ETFs are concerned, we expect to see more ETFs. We're very bullish on the growth outlook for the industry. More specifically, we expect to see more international, real estate and fixed-income based ETFs, as well as currency and natural resource-based ETFs. Of course, we expect also see enhanced index ETFs (which I think will be quite popular) and actively managed ETFs, which will one day be a huge marketplace.
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Q. Some observers have suggested that the scandals in the mutual fund industry has benefited Closed End Funds, ETFs and Separately Managed Accounts. The strong come back of equity CEFs surprised many observers. Some product specialists however have suggested that CEFs have benefits from a structural point of view like ETFs in that they can be structured to be tax-efficient like ETFs. Can you comment on
this?
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A. Well, first of all there has been strong growth in the ETF market. ETF assets under management at the end of June reached almost $180 Billion, representing a rise of almost 20% from the $151 Billion at January 1. During the same period, open-end mutual fund assets have grown only about 1%, reflecting primarily the impact of 401K programs. While moneys have flown out of those fund management companies tainted by the scandal, they have redirected themselves into other mutual fund complexes. So while there has been growth in both open-end funds and ETFs, ETFs have reported growth rates above 20% each year since their inception a little over a decade ago. The strong growth is occurring because both individual investors and institutional are becoming more sophisticated and are using ETFs in every aspect of portfolio construction.
As for the Spitzer investigation and related scandals, we believe this growth would have occurred anyway on a secular basis. We don't think that the scandals really have had a big impact on overall inflows into mutual funds.
In terms of CEFs, in the last 18 months over 80 CEFs have been launched. There are now more than 600 CEFs holding about $1.7 trillion in assets. Like ETFs, CEFs enjoy a variety of advantages including their efficient portfolio management, the ability to leverage, the ability to invest in less liquid securities and their availability at a price below net asset value. So they will always continue to grow on the basis of those advantages. Also, there is a large brokerage community out there that likes to sell CEFs and they like to take advantage of the hefty commissions they receive for distributing them. So I think CEFs are here to stay.
In this respect, it’s important to mention that the CEFs that have been launched in the last year have been designed to take advantage of President Bush's reduction in dividend tax income earlier this year. These funds focus on lower risk, interest rate protection, inflation protection and tax-advantaged income (i.e., dividends). There's only been only one new international fund launched in the same period of time, so the growth comes from special market situations, such as rising interest rates, rising inflation, and tax bill-related developments.
I don't think the selling of these funds, the size of these funds or the number of the funds that have been launched have any direct correlation to the Spitzer investigation.
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Q. Powershares has recently opted for an IPO type of introduction with a 2%
concession on the offering. What do you think of this new distribution paradigm?
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A. I don't pretend to be an expert in the marketing of ETFs but I suspect these are designed to capture the interest of the financial advisors and the financial planning community to get those constituencies to promote ETFs, much like CEFs. There is a body of people out there who like to sell funds for a nice commission, and this will probably capture their attention. But ultimately, the proof will be in the pudding whether it is successful or not. The current offering of index ETFs seems to sate institutional demand. It is questionable whether there will be institutional appetite for a Powershares-type funds that will be bought to market. So almost by definition it will be a retail product and therefore the paradigm being used is an ETF distribution type of paradigm. I suspect some of these products will do fairly well if their mandates or objectives tends to fit in with market trends.
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Q. Why do you think Europe has moved ahead of the US in using actively managed ETFS?
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A. One reason is cultural, the second regulatory. On this side of the pond, it's been very difficult for anyone to find a methodology that will work, given the prerequisite in the US for transparency and low cost.
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Q. Do you see demand for actively managed ETFs or will ETFs be confined to indexed-based funds?
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A. I feel there will be a lot of demand for the actively managed ETFs once they come on to the market. I also suspect that there will be an increase in supply as fund management companies direct their product development towards actively managed ETFs. The ETF market will continue grow as a result, and one day could well be dominated by actively managed ETFs compared to now, where index-based ETFs predominate.
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Q. Do you think the debate of ETFs vs Mutual Funds is over?
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A. By no means. Open-end mutual fund products and ETFs can happily co-exist. There a good and bad open ends and good and bad ETFs. Obviously, right now, there are thousands more open-ended funds then there are ETFs, so it will take many years of strong growth for ETFs to knock mutual funds off their perch. In the meantime, both kinds of funds have their respective places in the structure of investors’ portfolios.
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Q. What would you do if you were not in ETFs?
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A. A professor of German language and literature. I probably would have gone along with that were it not for my introduction to financial services.
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