In a challenge to iShares, Vanguard has filed a registration statement with the SEC to offer seven bond index ETFs (Investment News). Three of the ETFs will invest in U.S. Treasuries (1-3 year, 3-10 year, and longer dated), three in corporate bonds (1-5 years, 5-10 years, and long dated), and one in MBS. Each of the ETFs comes with an expense ratio of 0.15%. The company is trying to take advantage of current investment trends, one of which has investors moving into corporate bonds (Forbes). Bonds funds in general have received $58 billion in May and June, up from $19 billion over the same two months last year. The junk-bond market itself has climbed 40% this year. While some investors are simply chasing returns, others are looking for new ways to diversify away from equities after the market sell-offs in the second half of 2008 and first quarter of 2009.

ProShares is launching the first 130/30 ETF strategy (see Pensions & Investments article, Nasdaq article). The 130/30 ETF (CSM) will track the Credit Suisse 130/30 Large-Cap index. The Credit Suisse 130/30 index was developed by Andrew Lo (CIO of AlphaSimplex Group) and Pankaj Patel (director of quantitative research at Credit Suisse). The ETF has an expense ratio of 95 bps, with a strategy that will offer "investors a transparent, low-cost means of achieving 130/30 beta and, potentially, alpha superior to what a comparable long-only large-cap strategy would deliver over the long run." A First Trust 130/30 Large Cap ETN (JFT) based on the 130/30 strategy was released just over a year ago (see previous post, MarketWatch article).

Not familiar with 130/30 strategies? Basically, the strategy uses leverage to short poor performing stocks and then uses the proceeds, along with initial capital, to purchase shares that are expected to do well. If is a form of the general 1X0/X0 long/short strategy, although the 130/30 ratio funds have seem to generate the most interest, producing a 130% long, 30% short strategy. Investors using the strategy will often mimic an index such as the S&P 500 when choosing stocks for the strategy. You can find additional descriptions of the 130/30 strategy here and here. Lo paper here.

Keep in mind that with such strategies the managers must pick stocks to go both long and short. Often there is feeling that you are market neutral, given that you have both long and short positions, but this is not the case. While traditional hedge fund might utilize a long/short strategy that makes them market neutral (beta close to zero), the 130/30 strategy is usually compared to a benchmark, such as the S&P 500, giving 100% exposure to the benchmark. As a result, the strategies are sometimes referred to as beta-one strategies. Furthermore, if the manager gets it wrong in either, or both directions, you may end up losing more than expected. As with most funds, good management is essential, regardless of the strategy.

Given the market beta exposure, these funds are useful if you have a positive market view and you believe that the fund manager can generate alpha from the short portion of the portfolio. If your view is neutral or negative, a hedge fund with an appropriate strategy might be better. If you have a positive market view but are not confident that your manager can generate alpha from short selling, then a long-only fund, or index fund, would be best. Keep in mind that such funds also trade more often, making them less tax efficient compared to traditional long-only index funds.

Note/Update: As a follow-up, I just ran across an excellent article at Greenfaucet that also provides details about the ProShares launch, and the success, or lack of success of the 130/30 funds. Check it out here.

ALPS has launched a new Equal Sector Weight ETF of ETFs (EQL) that provides an equal weight position in each of the nine Select Sector SPDR ETFs (see IndexUniverse article). The fund rebalances the sector positions every quarter. The attraction of the fund, beyond not needing to invest in nine different ETFs in order to get sector diversification, is that it is designed to avoid over-investment in “bubble” sectors that may have run-up too far, too fast. When their strategy was back-tested over the last 10 years, the EQL strategy of reducing the spread in sector returns outperformed the S&P 500 by more than 3% per year. The EQL ETF charges 0.55% in annual expenses, which includes the assumed 0.21% in expenses for the underlying nine Select Sector ETFs. The EQL ETF sounds like an interesting and useful product, although it is not entirely clear how accurate one can measure when to reduce exposure to bubble sectors going forward.

The Grail American Beacon Large Cap ETF is now being offered to the public. While this would normally not be a big deal, this ETF is unique in that it is being billed as the first actively managed ETF (see WSJ article). There have been other active ETFs that diverged from a specific index, but the stocks choices for the fund were generated by computer models, as opposed to having a manager pick the stocks. In the tradition of lower fees for ETF, fees will be 0.79%, lower than a mutual fund, but still higher than a typical straight index fund ETF. Like other ETFs, the funds holdings will be made public daily, similar to mutual funds. Whether the ETF will be successful will depend on whether the company can avoid front-running of large public positions, and whether or not investors, who are already skittish and getting conservative, will be willing to invest with a product and a manager with an unknown track record. If history is any indication, the outlook is not good, especially given the timing.

Vanguard is offering a small cap international ETF which tracks the FTSE Global Small Cap ex-U.S. Index (see Index Universe article). The fund considers both developed and emerging countries. While both "small cap" and "emerging" hint of increased risk, the ETF holds 2,100 different companies, providing broad exposure. The ETF also has a relatively small expense ratio at 0.38%, providing an inexpensive and diversified way to take on some international and emerging growth exposure.

As active investors continue to watch their portfolios fall, it is natural for even traditional buy-and-hold investors to not only consider liquidating existing positions, but also think about ways to hedge their portfolio (or even profit from the relentless downward trend). Since the easy short money has probably already been made, some investors and traders are turning to 2X and 3X inverse or short ETFs to juice returns. While such ETFs have been in existence for a while, and articles detailing the uses and pitfalls have surfaced (see two recent 2009 WSJ articles here and here), it is still worth reminding investors how double, triple, and inverse ETFs are better suited for day traders, and are not perfect tracking vehicles past one day. The reason for this is that with the right type of daily moves over an extended period of time, compounding errors can result in inverse ETFs generating overall losses, even when the reference index is down considerably. Tom Lauricella's WSJ article outlines why:

"For example, take a double-leveraged fund with a net asset value of $100. It tracks an index that starts at 100 and that goes up 5% one day and then falls 10% the next day. Over that two-day period, the index falls 5.5% (climbing to 105, and then falling to 94.5). While an investor might expect the fund to fall by twice as much, or 11%, over that two-day period, it actually falls further -- 12%. Here's why: On the first day, doubling the index's 5% gain pushes the fund's NAV to $110. Then, the next day, when the index falls 10%, the fund NAV drops 20%, to $88."

So while a 2X short ETF will double your daily returns when the associated index is down by X, holding periods longer than one day are subject to compounding variations. Unfortunately, such compounding effects may not be the only surprise for long-term investors of index ETFs, or even those with shorter holding periods. Investors need to fully understand what is being tracked. For instance, the popular USO ETF actually trades based on crude oil futures, and not the spot price of crude. As such, if futures prices do not increase as much as the spot price, your ETF may end up gaining less than expected. Rolling from one contract month to the next could also cause gains or losses. If the crude oil futures market is in contango (futures trading for more than spot), rolling over the futures from one month to the next could generate a large loss for the ETF, and lower gains for the investor, as new positions are purchased at a higher price [Note: for a good overview on the issues regarding the USO, see the following seekingalpha article].

As with all ETFs, make sure you look beyond the name, and have some idea how the price is set. The various 2X and 3X inverse ETFs may not be giving you the type of long-term hedge or position you are expecting, and the commodity ETFs may not be following the spot price as anticipated. Finally, always be sure that any index the ETF is following actually has the type of diversification and representation you are looking for. Some industry ETFs may be heavily weighted in just a few companies, or may be focused more on a specific sub-industry.

The Nasdaq is planning to launch a series of trading and investment products based on companies receiving TARP money (see WSJ article). The first is the GRI (Government Relief Index), tracking 24 companies that received over one billion dollars in bailout assistance. The index is being pushed as a way to track the effectiveness of the TARP, yet it seems that for the index to be successful (profitable), it either needs to be widely followed and reported, or used as a vehicle to be traded against. The first seems unlikely (since many will argue that the success of TARP is not based simply on the individual companies doing well), and the second seems counter-intuitive, or at least counterproductive. Given a potential ETF product, it is not exactly clear how making it easier to short the companies in trouble and needing assistance helps the recovery. Maybe a simple "dead or alive" count would be easiest, but even that is difficult to gauge. Is Bear dead or alive? How about Merrill? Fannie or Freddie?

Money continues to flow into gold assets and gold ETFs (see Time Online article). The SPDR Gold Trust has expanded its holdings by 26 percent since the Lehman Brothers failure. South Africa has temporarily run out of krugerrands, and the US Mint has also temporarily suspended sales of American Buffalo bullion coins (American Eagle coins were already halted in August). Maybe this is a contrarian sign. The market action today certainly is promising.

There is an interesting BusinessWeek article that is worth the read if you invest, or are planning to invest, in a commodity fund. Since most commodity funds invest directly in futures, how those funds are managed can have an effect on returns.

One area of difference is how the fund manages margin. Since the fund is purchasing futures, margin must be set aside, but it is up to the fund to determine how those funds are invested. Some of the more conservative funds will purchase Treasuries, while others will invest in higher yielding bonds. Over the long haul this can have a noticeable effect on overall returns (and risk) for the fund.

Another area of difference which may have an even bigger impact is the effect of "roll yield." Roll yield is the positive or negative return you get when you sell one futures contract and/or roll an expiring contract into a new one. How often this is performed depends on both the duration of the contracts (how often they have to be rolled over), and any strategy employed by the commodity fund to try and manage the duration exposure. Depending on duration and strategy, having prices go into either contango and backwardation can have either a positive or negative effect on the commodity portfolio.

Some funds will only invest in short duration futures, essentially trying to mimic the commodity spot prices as close as possible. Other managers believe the fund is a long-term investment, and should be managed as such. These funds will buy contracts with durations from 3 months to 3 years. Various strategies and back-testing are performed to find the best contract durations based on whether the market is in contango (longer-duration contract prices are higher) or backwardation (longer-duration contract prices are lower).

Initial results are somewhat inconclusive as to which strategy is the best - i.e., managing the duration works sometimes, and sometimes it does not, especially if the dynamics of the market have recently changed. This is especially true of crude oil futures which seem to be affected on a daily basis by new variables in somewhat unpredictable ways.

Nonetheless, when purchasing a commodity fund it is worth thinking about what type of management you are comfortable with. Do you want relatively passive management with a fund that mimics the spot price dynamics - both good and bad? Or do you want a fund that tries to more actively manage the contract durations, allowing the fund to respond better when the market is either in contango or backwardation - even if fundamental and technical changes can put the fund on the wrong side of the market? As usual, it is often a matter of personal preference and current exposure. Unfortunately, while investing in commodity funds is certainly easier than trading futures for most, you still need to do your homework.

Are you interested in wind energy, but don't have billions to invest like T. Boone Pickens? Are you afraid that you are going to pick the next pets.com, and not ebay.com? Don't fear. IndexUniverse.com is reporting that the PowerShares Nasdaq OMX Clean Edge Global Wind Energy Index (ticker: PWND - prospectus) is expected to begin trading next week. It is actually not the first wind ETF. A few weeks ago, the First Trust ISE Global Wind Energy Index Fund (ticker: FAN - prospectus) hit the market. The PWND ETF will begin with 31 companies in its portfolio. The FAN ETF currently has 67 companies. Both have a high level of global diversification, which makes sense, given that I am not sure how they could even find 31 companies in the U.S., let along 67, with a significant exposure to wind energy. As a result of reaching out to global players, PWND is able to list that 90% of its companies are pure-plays. FAN has about 66% pure-plays. What is a pure-play? As defined, most of the business in the company must comes directly from wind energy - or specifically, the company must either produce 1,000 megawatts of energy, or generate $1 billion a year from wind-related power. Non-pure-plays include companies such as General Electric and Siemens, each which have significant interest in wind energy, but for which wind is still a relatively small profit center when compared to other business operations.

In addition to capitalization requirements and weighting rules, the funds also differ in the way they pick their companies. PWND uses a quantitative-based system, while FAN uses more fundamental analysis. Since the methodologies used by each are different, both are expected to deliver similar, albeit different returns. Given that wind energy has been growing at almost 30% per year globally, and crude oil and natural gas are continuing to trade at high levels, wind energy should continue to generate interest and electricity as countries going green begin using less coal to fuel their power plants. Nonetheless, if tax breaks expire, and crude oil and natural gas come back to "normal" levels, interest in wind energy could fall back a little, adding some potential volatility to returns.

Given the global nature of the funds, and that the industry is just beginning to gain exposure, many of the pure-play wind companies are not well-known. For the FAN ETF, major holdings greater than 5% include Vestas Wind Systems, Repower Systems, Gamesa Corp Tecnologica SA, and Hansen Transmission International NV. Given that the PWND ETF follows the Nasdaq OMX Clean Edge Global Wind Energy Index, major components can be found here. The top five holdings greater than 1% include Zoltek Companies (ZOLT), American Superconductor Corporation (AMSC), KHD Humboldt Wedag International, General Electric (GE), and FPL Group, Inc. (FPL). Other U.S. listed companies in the FAN include AES Corp. (AES) and Xcel Energy (XEL).

IndexUniverse.com is reporting about a new global index fund offered from Vanguard, called the Vanguard Total World Stock Index Fund. The new fund tracks the FTSE All-World Index, which currently weights the U.S. at 41% and the rest of the world at 59%. The index includes both developed and emerging markets, covering approximately 2,900 large and mid-cap stocks from 47 different countries. Talk about diversification. Investor, institutional, and ETF shares are offered. The fund trades under the symbol VT on the NYSE Arca exchange.

Not to be outdone, Northern Trust has registered, but not yet offered, an ETF to be called the Dow Jones Wilshire Global Total Market Index Fund. What a mouthful. The index will cover 58 countries and more than 12,800 companies. Can you say transaction costs? At least one broker will be happy.

Increasing leverage has worded so well over the last few months (tongue firmly in cheek), that it only makes sense to give average individual investors the same opportunity to seek a Fed bailout. Fortunately, roulette players now have a vehicle tailored just for them. Rafferty Asset Management has entered the ETF market, but not in an ordinary way. The firm has registered 34 ETFs based on various market indexes, each of which will deliver 3x the daily return (or inverse for the short ETFs). I am sure John Bogle, the champion of index ETFs, is not amused.

It is worth knowing that the ETFs deliver 2 or 3 times the daily return of the index concerned. Therefore, if the index goes up 1%, you do not necessarily get a 2% or 3% return. The 2x or 3x calculation only works from market open to market close. As such, these ETFs are tailored for daytraders and speculators that trade often during the day. The models could possibly be used for hedging, and would reduce the size of the position, but this does not appear to be the intended audience.