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					                                              July 23, 2009
                                  ETF Panel Discussion
                                presented to CFA MN Luncheon

Online resources:
etfconnect.com              ishares.com     proshares.com           ipathetn.com
indexuniverse.com           etftrends.com


Recent ETF developments:
• U.S. ETF assets rose to $598 billion at the end of Q2, up $68 billion YTD (positive net cash flows
of $42 billion and market advance).
• There were 16 new ETFs launched in June, versus 29 new ETFs launched in the first five months
of the year. Ten of the 16 were new funds launched by ProShares.
• Net new issuance of ETFs in 2009 has now offset the 42 closures that occurred earlier in the
year.
• “Traditional” equity ETFs have seen $33 billion of net outflows so far in 2009. Also, developed
international ETFs had net outflows. SPDR S&P 500 ETF (SPY) has had net outflows of $30 billion
YTD.
• Fixed income ETFs have been the big gainer this year with positive net flows in every month
totaling $23 billion YTD.
• About one‐half of all net inflows to ETFs so far this year have gone to levered or inverse ETFs.
• On June 25th, ProShares launched its first 3X, or 300% daily long or short exposure ETFs
competing directly with Direxion in the 3x market. ProShares currently has more than 90 new
ETFs in registration.
• Commodity ETFs took in nearly $21 billion of net inflows during the first 6 months of 2009. The
SPDR gold ETF alone had $11.9 billion of net inflows and is now the second largest ETF with
assets of $33 billion.
• Hedge fund strategy ETFs were recently introduced by IndexIQ. More to come.
• Barclays (BGI) introduced two new funds in June – Emerging Markets Infrastructure and all Peru.
• On June 30th, Macro Markets brought two home price securities to market – MacroShares Major
Market Up and Down – designed to deliver 300% of the S&P/Case‐Shiller Home Price 10 Index.
• In July, Javelin Exchange Traded Shares, or JETS, issued the first ETF tied to Islamic beliefs.
• TXF Funds has filed to launch a state‐specific equity ETF – Texas. 49 more to follow?
Questions:
1. Please discuss the general mechanics of ETFs, including the creation/redemption process.
2. What is the intraday intrinsic value, or iiV? Can you find the iiV by simply adding .IV to any
symbol?
3. BlackRock just bought Barclays Global Investors (BGI), including Ishares. Jack Bogle recently
commented that they paid a lot of money for a low‐fee business. No one really knows what this
means for the ETF industry. What are the concerns/issues associated with this merger?
4. What are ETNs (Exchange Traded Notes) and how do they differ from ETFs?
5. The industry is beginning to use the acronym, ETP, or Exchange Traded Product, to encompass
the various structures that are not actually funds, including ETNs and levered and inverse
product. Isn’t it misleading to group all of these products into a generic term “ETF”?
6. ETFs have been around since at least 1993. Detractors said they would blow up in periods of
market distress. Last fall, several bond ETFs began trading a significant discounts to NAV. In
general, discuss what happened. Is it true that the ETFs were the “real price” and provided price
discovery?
7. Institutions are increasing as a percent of ETF ownership. Shortly after Vanguard introduced its
brand of ETFs, they stated that as much as 40% of their ETFs were owned by other Vanguard
mutual funds. Who owns ETFs and has the ownership changed (institutions verses retail)?
8. Hedge funds and other institutions are setting up pairs trades using ETFs and making big bets up
and down. There have been certain ETFs that have had short interest that was 3 times the
outstanding shares. Discuss what happens when an ETF is shorted. Specifically, is it true that
the shorting process can actually create demand for the underlying ETF?
9. ETFs rarely pay out capital gains. In general, please explain why this is true. Also, is it true that
ETFs can assign their highest cost shares to redemptions, thereby managing down unrealized
gains?
10. Jack Bogle has been a harsh critic of ETFs. In general, he thinks god created index mutual funds
and the devil created ETFs to help investors lose money more efficiently. He recently tempered
his rhetoric and admitted that a buy and hold ETF is a good as an index mutual fund. But he
does make a few good points about trading costs (bid ask spreads), transactions costs, turnover
and trading losses. Please discuss some of these issues, including any tips on how to buy and
sell ETFs – i.e., using limit orders and how to use the iiV.
11. FINRA recently issued a warning to ETF providers, brokers and registered investment advisors
regarding levered and inverse ETPs. The warning stressed the need for investor education and
suitability requirements. Twele Capital has begun adding specific language to its client
Investment Policy Statements either prohibiting or strictly limiting the use of levered and
inverse ETPs. The company’s insurer recently requested specific information regarding the use
of levered and inverse products. What are the issues that should concern fiduciaries?
12. The daily rebalancing of levered and inverse products is complex. Critics charge that as much as
40% of the daily market volume for certain underlying securities can be associated with this
rebalancing. More important, some fear that most of the trading volume near the close is
dominated by speculative influences surrounding daily rebalancing activities. Barclays Global
Investors recently issued a white paper entitled The Dynamics of Leveraged and Inverse
Exchange‐Traded Funds by Minder Cheng and Ananth Madhavan that details the consequences
and some of the risks associated with growth of assets in levered ETFs. The conclusion is that
these funds represent a whole new source of systematic risk. What are the facts?
13. A lot of ETFs have expense ratio waivers that expire in the coming years. The providers waive a
portion of the fee to get the funds launched. Are these “teaser” rates? Are we going to see the
real cost of ETFs rise? What has been the trend in fees?
14. ETFs present a clear competitive threat to traditional index mutual funds. Last year, however, it
appears that ETFs drained a lot of assets from active mutual funds. Now we have active ETFs
that are hybrids; how have the active products performed?
15. ETFs have had a tough time breaking into the 401K market. Barclays seems to have made big
gains recently. In general, there is a lot of buzz about introducing ETFs into the defined
contribution market. What are the key issues? Who is Invest n retire and what does their
platform do?
16. Levered ETFs use swaps to create the desired exposure. Swaps have counterparty risk. Explain
this process. Also, what are the issues associated with the counterparty risk?
17. Russell Investment Management Company recently made filings with the SEC to enter the ETF
market. Pimco recently introduced its first ETF and others, including Eaton Vance, are rumored
to be contemplating ETF offerings. The field is getting crowded. Several questions come to
mind: Are there too many ETFs? Is there an ETF bubble? What happens when an ETF closes?
18. Here is an example that helps explain how a levered inverse ETF can part from the underlying
index over even a short period:
Day 1: Index Level 100
‐200% ETF Level 100
Day 2: Index rises by 10%
Index Level 110
‐200% ETF Level 80
Day 3: Index falls 10%
Index Level 99
‐200% ETF Level 96

				
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