What Should Come Next In ETFs?

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In the last few days there have been a couple of posts touching on the idea of what direction the ETF industry might go in; one from Mebane Faber revisiting a wish list from four years ago and the other by Richard Bloch from Zecco noting that iShares is soliciting ETF ideas.

The line in the sand for me is plain vanilla exposure versus very complex exposures. Every week we get a new VIX product to consider. The calculation of VIX is a very objective calculation of option prices. However the things that influence those option prices is very subjective and prone to changes. This makes VIX complicated. So any fund comprised of VIX futures or using some sort of strategy with VIX futures stands to be much more complicated for the end user. Since inception the VXX ETN is down 92% in almost a straight line with a one for four reverse split along the way. In that same time the actual VIX index is down more like 65%. Complicated.

This is not to say that a double short ETF is not also potentially complicated but I believe much less so. If the VIX index is up 4% today there is no certainty as to what a futures based fund will do today. There might be a probability of some result but no certainty. However if the NASDAQ drops 4% today there is a specified result that should occur in a double short NASDAQ ETF, it should be up 8% and the odds are overwhelmingly in favor of that occurring. Even so there is some reliance on something working the way it is supposed to but less so than with a VIX product.

I am also partial to products using the Diversified Trends Indicator. This is a rules long short strategy that uses futures. We've had good luck with this in mutual fund form and recently WisdomTree came out with the strategy in ETF form that I'll be writing about this week at TheStreet.com. Rules based creates a probability of outcomes even if not a certainty that I think makes for much easier investing.

As far as equity ETFs I would like to see funds that offer access to narrow themes like the recent Global X Uranium ETF (URA) or the Market Vectors Rare Earths/Strategic Metals ETF (REMX) or take a more focused approach like maybe a frontier market financial sector fund. The emerging market financial funds are dominated by markets that I personally don't care for; I've said repeatedly I don't want exposure to Chinese financials for example. The banks from smaller emerging and frontier markets frequently are better holds--well better than Chinese banks for my money.

With fixed income funds I think there needs to be more specialization with foreign exposure. The Japan heavy funds that exist now have not been problematic thus far but at some point I would expect them to be dangerous holds. They are heavy in Japan because Japan has the most debt outstanding. I don't know when the yen will be problematic, maybe never, but this is an issue to be very aware of. As I have pointed before there are all sorts of indexes that exist for this space in terms of individual countries--licensing an existing index would seem to be much easier than creating one from scratch.

With commodities I suppose people want more in the way of physically backed funds as opposed to futures based and apparently a physically based copper ETF will be in the US soon. One thing I don't quite understand with these is how storing a nominally cheap commodity--something that costs a few bucks a pound--can possibly be economical. I believe there is a copper ETF already trading in London so this issue has probably been addressed. Physical storage of agricultural commodities could also be problematic for spoilage but I've not heard much about proposed funds in this regard.

The industry will of course evolve, will of course offer plenty of new products many of which will go nowhere but some of which will prove out to be transformational is a positive way. The best thing we can do for ourselves is to stay informed and be selective.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , ETFs

Referenced Stocks: REMX , URA

Roger Nusbaum

Roger Nusbaum

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