Mark Abssy is the
Index & ETF Manager
for the International Securities Exchange. In this capacity,
Mark is responsible for all phases in the development of
innovative tradable products from concept to commercial
Prior to joining ISE, Mark has held various product
management positions at Morgan Stanley Investment Management,
Fidelity Investments and Loomis Sayles & Company LP and has
worked on the institutional client side, managing short-term
investments for Genzyme Corporation. Mr. Abssy is a member of the
CFA Institute and the New York Society of Security Analysts. He
received a BSBA in finance and international business from
Northeastern University in Boston, Massachusetts.
Mark recently sat down with Seeking Alpha's Jonathan Liss to
discuss the ISE's unique approach to indexing, offering much
insight into the 10 (and counting) ETFs currently based on ISE
Seeking Alpha ((
Thanks so much for taking the time to speak with us Mark. When and
why did the ISE get into the indexing business? What has your
experience been so far? At what point did you begin designing
indexes with ETFs in mind?
Mark Abssy ((
We started developing indexes in 2005. At that time, our focus was
on developing indexes that we would use as the underlying for the
derivatives contracts, options specifically. In 2007, we realized
the opportunity available to us in the ETF space and have been
enjoying what I like to call "modest success" in the space with
approximately $1.2 billion of ETF assets tied to our indexes.
How does the decision process work in terms of which indexes you
have decided to create? Is it just about gaps in what's available
to investors, or is it more about focusing on areas you feel you
have real expertise and an ability to add value for investors?
Product design ideas can come from any number of places. While we
look to fill gaps in investors' portfolios, we do so by looking to
fill gaps in ETF issuers' product lines - after all, an idea
without a product is still "just" an idea.
The expertise question is interesting. I wouldn't necessarily
say that we are experts in every single sector or area in which we
produce indexes. I equate "expert" with being a seasoned industry
analyst with his finger on the pulse of the industry in question
with earnings targets, broad industry forecasts and thoughts and
opinions on each company's management team. We can certainly speak
to the fundamentals of an industry, but we're not a research shop
in the classic sense. Where we look to add value is in devising the
right methodology for the index and selecting components that will
achieve the desired exposure.
What was it about standard cap-weighted indexes that you feel
offered investors an unsatisfying investing experience?
Most of the industries/strategies covered by our indexes have
companies with a wide range of market capitalization. We feel that
allowing the larger cap companies to dominate deprives investors of
participating in the growth opportunities provided by smaller
companies. Further, it is often the smaller companies that provide
true pure play exposure to an industry, particularly an emerging
Have you found the heavier weighting of smaller cap companies
within many of your indexes has led to underperformance vs.
comparable cap-weighted sector indexes in down markets, as is
frequently the case with small caps during market sell-offs? Would
you say weighting or component selection have ultimately had more
of a beneficial effect on ISE index performance?
We use various weighting schemes as a tool to level the playing
field in terms of providing exposure. We do want to give larger,
more established companies a higher allocation but not so much that
they end up drowning out the smaller names. I haven't run the
attribution modeling, but I would say that from a performance
perspective, component selection provides more impact to returns
than the allocation methodology.
As to your question about small cap impact in down and up
markets, this classic observation doesn't really play out in most
of our indexes. The indexes tend to focus on narrow segments of the
economy so any cap biases tend to be overshadowed by the overall
health of the sector in question.
Let's discuss some of your indexes that have been tied to specific
ETFs. Probably the most popular of these is the ISE-Revere Natural
Gas™ Index ((FUM)) which is currently tied to 3 ETFs: [[FCG]] from
First Trust (which currently has more than $650 million in assets)
and the leveraged and inverse leveraged [[FCGL]] and [[FCGS]] from
Direxion. Why has FCG outperformed natural gas futures ETFs like
UNG and GAZ so significantly? It seems the outperformance would be
significant even with the contango issue removed from UNG's and
GAZ's long-term performance.
Outperformance of FUM over natural gas spot prices has to do with
the idea that natural resource companies are inherently leveraged
to the underlying natural resource they produce, extract or mine. I
like to think about it in terms of what components go into valuing
something. In commodity spot markets, prices are determined almost
entirely on the current supply/demand curve. Equity valuation is
much more complex, but my point here is that much of a company's
valuation is derived from future expectations. As the price of a
commodity rises, there is a kind of future earnings compounding
effect that builds itself into the stock's current price.
We've seen this over time with natural gas stocks but there have
been other recent examples, like last year when copper prices
spiked. Copper spot prices jumped 10.24% from August 31 to the end
of October 2010 and the ISE Global Copper™ Index rose 33.53% in
that same time frame. What's interesting is that copper prices had
been rising since May of 2010 and the index was rising too, but in
lockstep with spot prices. It was only when copper spot prices hit
a certain level that valuations on the companies in the index
really took off.
Your natural gas index is interesting for a few reasons, notably
the fact that it's equally-weighted and the fact you're using a
'value-investing' bias in the screening process. Are these
strategies you feel investors should be applying to all index
selection? If not, why for natural gas specifically?
Except in times of mania, every investor is a value investor
(except maybe dedicated momentum investors). Because we had
identified more than enough names in the space to maintain an
index, we decided that including these screens would be additive to
the process. Investors realize diversified exposure to the natural
gas space and are doing so with a value bias. Not a bad
With regards to applying this same selection and weighting
methodology to all indexes, we develop index methodologies to
custom fit the space we are in. What works for natural gas may not
work for copper, which in turn won't work for wind energy, etc.
Another interesting fund you built the index for is the First Trust
ISE Chindia™ Index ETF (
). Where'd you come up with the idea to pair China and India? Are
there advantages to populating the Chindia index solely with
Chinese and Indian companies that trade in the U.S.? Are there
sectors you wish were more or less heavily weighted?
The rationale behind this one is really quite straightforward
because I think the demographics of this trade speak for
themselves. While we wanted to get exposure to these markets, the
data we needed was difficult to obtain, and the markets even more
difficult for issuers to access. If we were looking to create a
more traditional benchmark then we would have used locally traded
shares, even though the index would not have been readily
investible for investment managers outside China and/or India.
In terms of sector exposure, the methodology guide naturally
allocates names to those sectors dominating the space as defined by
market cap and liquidity. Despite the role of market capitalization
in component selection, final weighting is determined by equal
weighted tiers. Again, we are looking to provide exposure to the
theme, not trying to anticipate the next breakout sector.
Going back to the launch of the First Trust ISE Water Index™ ETF (
) in May of 2007, the fund has crushed the three similar ETFs
currently trading in the U.S. ([[CGW]], [[PHO]], [[PIO]]). This is
a great lesson on the importance of choosing the right indexes when
building your portfolio. What about the composition of this fund
has made it such a great performer? Do you think investors can
expect reversion to the mean here?
Of the three funds you mentioned, the only apples to apples
comparison I would make is FIW against PowerShares Water Resources
Portfolio ETF (
) as the indexes for both funds are constrained to U.S.-listed
names only. In looking at the long-term returns, FIW dominates
I honestly can't point specifically to the "one thing" that the
ISE Water™ Index ((HHO)) has or does that provides a clear
explanation for this [outperformance]. The underlying index for PHO
is an equal weight index that rebalances quarterly while HHO
utilizes a tiered weighting methodology that rebalances
semi-annually. HHO's minimum market cap is $100 million ($50
million less than the other index) but the liquidity requirements
(shares traded) are ten times as high (1 million as compared to
100,000). My guess is that a combination of differences in
weighting methodology and timing of rebalance cycles play into the
outperformance. Of course, FIW's lower expense ratio helps as
Mean reversion? I like to think that our index is the mean.
Hopefully, investors will come to the conclusion that the way to
get these returns is to invest in FIW, not hope that FIW is going
to undergo some type of mean reversion.
Crouching Tigers, Hidden ETFs: AIA vs. ASEA