Hougan: My Favorite 2013 ETF Is SRLN

Editor's note:Matt Hougan, IndexUniverse's global head of content, has had a ringside seat in the ETF industry for years. In this new feature, IU editors and writers will sit down with him at the end of every month to share with our readers some of his thoughts and insights in the world of ETFs .

This month, IndexUniverse.com Managing Editor Olly Ludwig caught up with Hougan for a chat, and they had a lot to talk about, not least the astonishing success story of the WisdomTree Japan Hedged Equity Fund (NYSEArca:DXJ). But Hougan also said his favorite new ETF this year is the SPDR Blackstone/GSO Senior Loan ETF (NYSEArca:SRLN), an alternative yield-generating fund that illustrates thoughtful active management clearly still has a role in a world of ETFs thoroughly dominated by index strategies.

IU.com:Do you have a recent favorite ETF?

Hougan: Sure. There have been about 50 funds that have launched this year, and I actually find it an incredibly interesting class. There are a few that I like, and then one favorite. One that hasn't caught on is the Global X Nigeria Index ETF (NYSEArca:NGE). I'm a big fan of the frontier markets. I think that's an interesting play. The market may be overheated and the ETF certainly has not gotten traction yet. But it's emblematic of ETF issuers pushing into the frontier, and offers an interesting new kind of return.

IU.com:That's not your favorite; that's just one of them, right?

Hougan: That's just one of them, yes. I actually like the Credit Suisse Gold Shares Covered Call ETN (NasdaqGM:GLDI). Terrible timing; you couldn't have picked a worse moment in the last 10 years to launch that product. But the concept of generating income from an asset thatotherwise only generates dust is an interesting one. And putting it in an ETN package is actually a very-tax-efficient way to deliver that pattern of returns. I think it will catch on long term.

But my favorite is the SPDR Blackstone/GSO Senior Loan ETF (NYSEArca:SRLN). It's also the most successful product to launch this year, with $240 million in assets in less than two months, so maybe I'm not saying anything interesting. But I think what we've seen from the Pimco Total Return ETF (NYSEArca:BOND) is that in the deeper, darker corners of the fixed-income market, there's still opportunity for sensible active management. Bond indexes are terribly structured, and as you get into more inefficient corners like senior loans, the opportunity for upside is larger. This is an interesting play on that idea. I think it will be an enormously successful fund, and I bet the performance will be relatively strong as well.

IU.com:Let's talk about ETNs and AMJ. AMJ went back into a premium this month because of some kind of shenanigans in the options market. I confess AMJ's premium gets me all worked up. Do AMJ's problems say anything about ETNs in general?

Hougan: Well, anytime an ETN is capped out on creations, it stops being an ETF and really becomes a closed-end fund. That's the case with AMJ. It's at its creation limit; you can't make more shares of it. So anytime there's incremental demand, it will trade to a premium, and investors will get hurt when that premium deflates. That problem doesn't extend to all ETNs, because not all ETNs are at their cap and not all ETNs even have a cap. But ETNs are more liable to cap out than ETFs, so there's more risk there. Anytime one trades to a premium, you should cash out because you know that premium is going to deflate.

IU.com:So the Etracs Alerian MLP Index ETN (NYSEArca:AMU) is the answer here? It was predatory marketing by UBS. It came out right when AMJ's premium problems started a year ago. It's the exact same product, and it's 5 basis points cheaper than AMJ!

Hougan: There you go. Absolutely. Why not? Just trade carefully.

IU.com:Let's move to Japan. It's a huge story this year. We talk about the WisdomTree Japan Hedged Equity Fund (NYSEArca:DXJ) and the db X-trackers MSCI Japan Hedged Equity Fund (NYSEArca:DBJP, all the time. DXJ really took off, as you know. Even DBJP became a $100 million fund this year, so it doesn't have the liquidity problems that dogged it in the early days. So, does this currency-hedged phenomenon have legs in Japan and elsewhere and, if that's the case, what do you favor:DXJ or DBJP?

Hougan: Great question. A lot of the interest in the currency-hedged ETF space was created because of the spectacular situation in Japan, where the difference between a hedged product and an unhedged product hasn't been a couple of percentage points, but 25. DXJ is a spectacular product for a spectacular time. It's unique.

But the concept of currency hedging-if investors are serious about it-could be significantly larger than it is today. Imagine you were a tactical ETF manager, or a tactical macro investor, and you were starting from square one building an investment policy statement. A legitimate step in that process at the outset might be to ask yourself:Am I bullish or bearish on the dollar?

Depending on your position on the dollar and the currency, you might want to hedge all of your portfolio or you might want to rotate from a hedged portfolio to an un-hedged portfolio. There's essentially no intellectual difference in making a call that, say, Canada's market is going to go up and saving that you think Canada's currency is going to go up. Those are both legitimate macro calls to make. You've always been able to express one with an ETF; now you can express the other.

So I think there will be a sophisticated class of tactical, global, ETF managers who will currency-hedge a significant portion of their portfolio-perhaps all of it, and perhaps rotating back and forth.

My guess is that this boom we've seen will quiet down because Japan has already retreated. But the long-term shift toward offering investors and advisors the ability to currency-hedge I think will be significantly bigger than a lot of people think.

IU.com:And that possibility of rotation that you just spoke about would favor a fund like DBJP over DXJ because DBJP is so similar to the iShares MSCI Japan Index Fund (NYSEArca:EWJ), I presume, right?

Hougan: Absolutely. I own DXJ-I've owned it for five months or so. But I think DBJP is the better product, because it allows that pure 1-for-1 rotation from EWJ into DBJP, and it isolates the currency decision from a number of confounding factors that the other product introduces.

IU.com:Let's turn to China. It's obviously a huge story that continues to evolve. In the news traffic, we've seen KraneShares, an upstart that's about to roll out a whole bunch of China-specific funds. We also saw RevenueShares get a private-equity investment from a Chinese firm. What are your thoughts about these latest turns of events?

Hougan: The KraneShares launch strikes me as similar to Credit Suisse's GLDI launch. You couldn't have picked a worse time over the last 10 years to introduce new China products. We've seen outflows from China ETFs; there are a huge number of people who are bearish on China; investors are trying to diversify their emerging markets exposure to other markets.

I don't know that the world is clamoring for more nuanced China ETFs at this point. We already have the products from AlphaShares. I don't know quite where KraneShares fits. I wish them the best.

What I see investors doing in the emerging markets space is rotating more into thematic products. The growth of the EGShares Emerging Markets Consumer ETF (NYSEArca:ECON) over the last year has been impressive-that's a $1 billion product now, which is huge. I think you're more likely to see that across-emerging-markets --- thematic play taking off than more nuanced slicing and dicing of China.

IU.com:And the thought that China is about to become a hotbed of ETF development is partly what RevenueShares is on about. They want to use this money from the Chinese firm to help them launch new products in the U.S., but also to help them bring ETFs to the Chinese market. Is that a realistic goal?

Hougan: There's a huge amount of skepticism from most senior people in the ETF industry about the potential for domestic-listing markets in Asia. The domestic market in Asia tends to be institutional, and they tend to be 100 percent comfortable buying U.S.- or London-listed products, which already have massive liquidity.

So that tilts the table and makes it very hard for local products to gain traction in a market like China. Mainland China certainly has a strong retail investor population, but it's really a single-stock culture, and the idea of macro-based allocation is in its infancy there. So, count me a skeptic of locally listed Chinese ETFs. That market is for a long time going to be focused on large institutions buying predominantly U.S.- and London-listed securities.

IU.com:Let's finish up with what you think is the biggest surprise so far this year in the world of ETFs.

Hougan: It's a simple answer:It's got to be DXJ. $10 billion for a product no one ever heard of?! I said earlier I thought currency hedging could be huge, but if you had asked anyone in the world if they thought WisdomTree would stumble on to a $10 billion Japanese ETF a year ago, the answer would have been no. It's really opened up a whole new idea for the ETF market-this idea of currency hedging. I think you're going to see a lot more of it.

A lot of people thought ETF innovation was done a couple of years ago and all the markets were covered. And then along comes DXJ, and it opens up a whole new world. Iif you don't believe me that it's the biggest surprise in the ETF industry, just look at WisdomTree's stock (Nasdaq:WETF). It has more than doubled since the start of the year.

So the answer to your question is DXJ-and by miles.

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

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

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