Fiducitation: Exchange Traded Funds (ETF’s)

Author: Fiducite Staff Capital Markets Team

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Synopsis

After one false start, several years of fighting for regulatory approval, another year to catch the eye of institutional investors, and more time to gain the attention of retail investors, Exchange Traded Funds are now one of the fastest growing investment vehicles in the world.

Net Asset Value for all ETF’s has at least doubled annually for the last six years.
According to State Street Global Advisors (SSgA), there was almost $89 billion in assets in 150 ETF’s worldwide as of the end of July 2001, up from $461m in the first ETF at the end of 1993.
ETF's now account for two-thirds of the daily volumes on the American Stock Exchange, which launched the first ETF’s in the US stock market back in 1993.

· From 1993 to 2000, ETF’s were only traded in the United States. Now they are now traded in at least 11 countries, with more countries looking for sponsors and filing for approval.

While the Net Asset Value for all ETF’s worldwide is growing rapidly, the market represents only 1.2% of the total mutual fund market. While at first glance, ETF’s may seem to be no competition to the more mature mutual fund market, these figures below indicate the momentum is changing.

Despite a market downturn, ETF assets under management actually rose by $2.8 billion in June and fell slightly in July ($40 m). During that same time, mutual fund assets shed $82.5 billion (or 1.2%) of their value in June and additional 46.8 billion (or 0.7%) in July.

· During December of 2000, ETF’s attracted as much new money as stock mutual funds, which received $11.58 billion of net new money, according to the Investment Company Institute (ICI).

The advantages of an ETF over a mutual fund are clear, and have made ETF’s a force the mutual fund industry is trying to figure out how to compete with or replicate.

ETF’s combine the most attractive elements of mutual funds - diversification of risk, reduced spread, and low fees - with the advantages of equities through high liquidity and accessibility.
ETF's are transparent and offer the ability to buy throughout the day, buy on margin, and short.
ETF’s have lower expense ratios, and are more tax efficient than mutual funds.

As of April 2001, three custodians dominate the ETF industry: State Street Global Advisors (45.67%), Bank of New York (34.59%), and Barclays Global Investors (17.07%). These custodians pioneered the ETF but they are already losing some of their market share to custodians offering new products around the world. All ETF managers face similar obstacles: marketing to institutional and retail investors, pro-viding the technical infrastructure to maintain an ETF, and winning regulatory approval in each country.

Table of Contents:

Synopsis. 1

Exchange Traded Funds Overview.. 2

Market Size of ETF’s and Mutual Funds. 3

The Comparison Between ETF’s and Mutual Funds. 7

International ETF Developments by Country. 9

ETF Custodian Market Share. 13

Additional Information. 14

Exchange Traded Funds Overview

Frequently Asked Questions About Exchange Traded Funds (February 2001)

Annotation: This page provided by The Investment Company Institute (ICI) provides an overview of ETF’s and comparisons to mutual funds in the US. It answers these specific questions below.

Clip:

What are the structural differences between ETF’s and mutual funds?
What are ETF assets relative to mutual fund assets?

· How many ETF’s currently are available to investors?

· How long have ETF’s been available to investors?

· What is in the portfolio of domestic ETF’s?

· Do ETF’s track international indexes?

· How are ETF’s regulated?

Link: http://www.ici.org/aboutfunds/etf_faqs.htm Cached File:

For additional overviews of ETF’s, the links below all provide high quality answers:

Link: http://www.indexfunds.com/articles/20001019_ETFFAQ_iss_etf_JW.htm (Oct 2000)

Link: http://www.nasdaq.com/indexshares/about_funds.stm (2001)

Link: http://news.morningstar.com/doc/article/0,1,3503,00.html (Aug 2000)

Link: http://www.chebucto.ns.ca/~rakerman/money/gm-The_ABCs_of_ETFs.html (Canada - Oct 2001)

Exchange Traded Funds: A White Paper

Annotation: This paper addresses the history of ETF’s, the different type of ETF’s, the mechanics of how they work, the characteristics of ETF’s, and describes the impact on mutual funds market.

Clip:

ETF’s allow investors to:

Trade the "market" with a single investment as easily as trading a stock.
Price, buy and/or sell at any time during the trading day
Margin.
Sell short. (ETF’s can be sold short on a downtick).
Execute all order types.

Link: http://www.indexfundsonline.com/WhitePaper.htm Cached File:

Market Size of ETF’s and Mutual Funds

Historical Record of Global Assets and Cash Flow of ETF’s and Mutual Funds

Annotation: At the end of 2000, ETF’s assets in the world totaled approximately $65 billion, which is less than 1% of the $7 trillion mutual fund market.

Clip:

Link: http://www.ici.org/pdf/per07-02.pdf Cached File:

Total Net Assets of International Exchange Traded Funds, 1993-2000 (billions of dollars)

Annotation: As this chart shows, the ETF industry is undergoing incredible growth. The United States, which has a seven-year head start on the Europeans, has dominated the industry in assets as of 2000.

Clip:

Link: http://www.ici.org/pdf/etf_figure1.pdf Cached File:

Mutual Fund Flows (August 2001)

Annotation: This table illustrates the mutual funds industry assets and net flows compared to last year.

Clip:

Link: http://www.frcnet.com/FRC/graphics/pdf/August01_NetFlows.pdf Cached File:

Exchange Traded Fund Assets (June - August 2001)

Clip:

Assets of ETF’s by Type ($millions)
	August 2001	July 2001	June 2001
Domestic (Broad-based)	63,248	67,028	66,921
Domestic (Sector/Industry)	6,747	6,650	6,721
Total Domestic	69,995	73,678	73,643
Global/International	2,090	1,842	1,917
All	72,085	75,520	75,560
Value of Shares Issued and Redeemed by All ETF’s ($millions)
	August 2001	July 2001	June 2001
Gross Issuance	5,420	5,615	7,235
Gross Redemptions	2,740	3,037	3,807
Net Issuance	2,680	2,578	3,428
Number of Exchange Traded Funds by Type
	August 2001	July 2001	June 2001
Domestic (Broad-Based)	33	33	30
Domestic (Sector/Industry)	33	33	30
Total Domestic	66	66	60
Global/International	26	25	25
All	92	91	85

Link: http://www.ici.org/facts_figures/etf_0801.html Cached File:

Trends In Mutual Fund Investing in US (June - July 2001)

Clip: The combined assets of the United States’ mutual funds decreased by 0.7 percent to $6.895 trillion in July, according to the Investment Company Institute's official survey of the mutual fund industry. Assets of stock funds declined by $87.11 billion in July.

Net Assets of Mutual Funds (billions of dollars)

	July 01	June 01	% chg	Dec 00
Stock Funds	3,589.9	3,677.0R	-2.4	3,962.3
Hybrid Funds	352.4	350.6R	0.5	349.7
Taxable Bond Funds	590.3	574.6R	2.7	530.1
Municipal Bond Funds	292.5	286.7R	2.0	277.9
Taxable Money Market Funds	1,814.9	1,804.8R	0.6	1,607.2
Tax-Free Money Market Funds	254.7	247.8R	2.8	238.1
Total	6,894.7	6,941.5R	-0.7	6,965.2

R=revised data

Link: http://www.ici.org/facts_figures/trends_0701.html Cached File:

ETF’s: The Growth Story of 2000 - 86% Growth (January 2001)

Annotation: Although this article by Financial Research Corporation has outdated figures, it makes bold

statements regarding the future of the ETF industry, including the one below.

Clip: Over the next five to seven years, FRC believes that total ETF assets could reach as high as $500 billion. We expect that ETF’s will be making headlines for many years to come.

Link: http://www.mfcafe.com/pantry/bps_012401.html Cached File:

The Comparison Between ETF’s and Mutual Funds

ETF’s Are On A Roll (February 2001)

Annotation: Although ETF’s are a mere 1% of the mutual fund industry, this article makes the observation that ETF’s have generated as much new money as stock mutual funds in December of 2000.

Clip:

· In its first statistical release on ETF’s, the ICI said these pooled investment vehicles, the shares of which are bought and sold on stock exchanges like publicly traded companies, had total assets of $65.6 billion at the end of 2000.

· That is tiny in comparison with the nation's mutual funds, which had combined assets of just under $7 trillion at the end of last year. But ETF’s, most of which trade on the American Stock Exchange, continue to grow rapidly in popularity with investors.

· At the end of December, there were 80 ETF’s in the U.S., all of them stock-index funds. Together, ETF’s in December attracted nearly as much new money as stock mutual funds, which received $11.58 billion of net new money, according to the ICI.

Link: http://www.financial-planning.com/Investments/Link Cached File:

AMEX: Managed Funds Face Threat (May 2000)

Annotation: Near the end of the article, this article offers perspectives on the future of mutual funds.

Clip: Some enthusiasts, including Mr. Bloom, predict ETF’s will relegate traditional, actively managed mutual funds to the dust heap of history. The notion of a mechanical index retiring all the stock pickers, as well as overcoming that tantalizing possibility of beating the market, is premature.

Link: http://specials.ft.com/ln/ftsurveys/industry/scd9ba.htm Cached File:

Fund Killers? Exchange Traded Indices Pose Threat to Mutual Funds (Jan 2001)

Annotation: This article provides differing points of view regarding the battle between mutual funds and ETF’s. Marketing may be ETF managers’ biggest obstacle.

Clip:

· These plans set the stage for a mammoth battle between traditional mutual funds and their exchange traded cousins. "I think the implications of exchange traded funds are a negative for the fund industry," says Henry McVey, a brokerage and asset management analyst at Morgan Stanley Dean Witter.

· Exchange-traded products are "a very small piece of the mutual fund industry," says Gus Fleites, head of exchange-traded products at State Street Global Advisors, the money management division of State Street Bank & Trust. To change that, two things need to happen. "One: Have more product come to the marketplace," Fleites says. "Two: Have the retail market buy into the structure, and that hasn't happened yet. You're up against the big mutual fund companies that spend millions and millions of dollars in advertising."

Link: http://www.thestreet.com/funds/deardagen/847792.html Cached File:

ETF’s Tax-Efficiency Edge over Traditional Mutual Funds (September 2001)

Annotation: This is a detailed article on how ETF’s have a tax advantage over mutual funds.

Clip: The simplest way to look at the tax benefits of ETF’s is to regard them as a trade. Where ETF’s often have nontaxable trades of ETF shares for underlying stock and vice versa, traditional mutual funds generally have sales events, which trigger tax consequences.

Link: http://www.indexfunds.com/articles/20010928_etftax_adv_etf_JW.htm Cached File:

Are ETF’s Better Than Stocks?

Annotation:

Clip: Another major difference between an ETF and an open-ended fund is that ETF’s trade the whole day on the exchange unlike the funds that have specific trade windows during the day. Plus, an investor can even short them, or buy on margin like a stock. Also, since the underlying stocks within an ETF don't trade that frequently the ETF’s don't surprise investors with large capital gains distributions and so they are tax efficient.

Link: Link_to_About.com Cached File:

Actively Managed ETF’s: Theory or Reality? (June 2000)

Annotation: This may be a relatively old article, but it provides obstacles and projections for actively managed ETF’s; a product that could save the job of many mutual fund managers.

Clip: We will explore the prospects for the creation of an entirely new class of ETF’s, which would not be tied to any index but instead would be actively managed for the first time.

Link: http://www.frcnet.com/FRC/research/art_ofin_actvmgd.htm Cached File:

International ETF Developments by Country

ETF’s: A Picture of Concentration (April 2001)

Annotation: This article details the market share of early pioneers of the ETF, and depicts how their dominant market share has declined as product offerings expand across the globe.

Clip:

Link: http://www.indexfunds.com/articles/Link Cached File:

A Discussion With Rainer Riess of Deutsche Börse AG (October 2001)

Annotation: This detailed interview gives Rainer Reiss’ perspective on the future of ETF’s in Germany and Europe as a whole. He explains many of the differences between ETF’s in Europe and the US.

Clip: The European market is not one uniform market like the U.S. It consists of 16 different countries and 16 different markets. Add to that different national legal frameworks, trading systems, and expensive clearing and settlement and it's no wonder you have difficulties with efficient cross-border trading. Consolidation in Europe is needed, but it will take time.

Link: http://www.indexfunds.com/articles/2001100401_riess_int_intl_JW.htm Cached File:

Link: German-language version of indexfunds.com

The First European Exchange Traded Funds (May 2000)

Annotation: As Europe began to offer ETF’s in April of 2000, ETF’s already represented between 50 to 70% of daily trading volume on the American Stock Exchange.

Clip:

· Run by Barclays Global Investors, the UK's first ETF’s called "iShares" track the performance of the FTSE100, and started trading on the London Extramark, on April 28, 2000.

· ETF’s now represent between 50 per cent and 70 per cent of daily trading volume on the American Stock Exchange, says Deborah Fuhr, vice-president, marketing, at Morgan Stanley International.

Link: http://specials.ft.com/ln/ftsurveys/industry/scd9a2.htm Cached File:

Japan Gives Green Light On ETF’s (May 2001)

Clip: Japan's Financial Services Agency (FSA) selected four indexes that will be eligible as the basis for ETF’s:

Tokyo Stock Price Index (TOPIX)

· S&P TOPIX 150

Nikkei 225
Nikkei 300

According to a statement released by S&P, Barclays Global Investors (BGI) will manage the S&P/TOPIX 150 ETF. "Japan is recognizing the importance of ETF’s, but we're waiting for the regulatory environment to catch up," said BGI spokesman Tom Taggart. In addition, the FSA has approved the listing of S&P/TOPIX 150 futures and options to be launched July 11, according to the Tokyo exchange.

Link: Link Cached File:

State Street Launches Amsterdam ETF (June 2001)

Annotation: This latest launch brings the total number of ETF’s trading globally to 151.

Clip: An ETF based on the AEX Index, a cap-weighted index comprised of 25 leading stocks traded on the Amsterdam Stock Exchange, began trading Wednesday, 5/30/2001. The new ETF, called the streetTRACKS AEX Index ETF, is managed by SSgA. The latest addition to the streetTRACKS family now brings the count to eleven - SSgA now manages 24 ETF’s total worldwide.

Link: Link Cached File:

State Street to Launch European ETF’s Based on MSCI Indexes (October 2001)

Clip: Today, State Street Global Advisors (SSgA) announced that it has entered into a license agreement with MSCI to launch ETF’s in Europe based on MSCI indexes. The announcement is the latest move by an asset manager to release ETF’s in Europe, where the products are in the relatively early stages of acceptance by institutional and retail investors. According to SSgA, it currently manages over $31 billion in 22 ETF’s worldwide. SSgA has plans to roll out a dozen new European ETF’s based on MSCI indexes, although SSgA has yet to announce which exchanges the new funds will trade on.

Link: Link Cached File:

NYSE-listed ETF to be Tied to Broad Chinese Index (June 2001)

Clip: FTSE/Xinhua Index Ltd (FXI) announced the launch this morning of a U.S.-dollar denominated version of the FTSE/Xinhua China 25 index that it anticipates will accommodate an ETF. Jane Staunton, president of FTSE Americas, notes that a Hong Kong ETF is expected "sometime this fall." FXI and NYSE say they are actively searching for a sponsor for the fund.

Link: http://www.indexfunds.com/articles/20010628_FTSE_new_etf_JW.htm Cached File:

Swiss Exchange Launches Broad Market ETF

Clip: Yesterday the SWX Swiss Exchange announced the launch of an exchange traded fund (ETF) that tracks the Swiss Market Index. This broad benchmark is a cap-weighted index that contains 29 Swiss blue-chip companies that represent 80% of the total capitalization of Switzerland's equities market. The ETF trades under the symbol XMTCH.

The new ETF joins two others that trade on the Swiss Exchange: STOXX 50 LDRS and Euro STOXX 50 LDRS, which are also cross-listed on the German Deutsche Borse and the Euronext exchange. The Swiss Exchange said it plans to further expand its ETF offerings in the coming months.

Link: Link Cached File:

ETF’s to Cross-Trade in Hong Kong

Clip: Hong Kong Exchanges and Clearing Limited (HKEx) has developed a new infrastructure to handle ETF trading in local time. According to Barclays Global Investors (BGI), six iShares will soon cross-trade on the HKEx. They are listed in the table below:

Link: http://www.indexfunds.com/articles/20010419_HKEx_new_etf_ST.htm Cached File:

ETF Based on Dow Begins Trading on European Exchange (May 2001)

Clip: The new ETF, or what the Europeans have dubbed "trackers," is called The Dow Jones Industrial Average Master Unit. Currently, there are 12 ETF’s that trade on Euronext, broken down into 4 families:

Master Family
Fund name	Index	Expense ratio	Inception date
Dow Jones Master Unit	DJ Industrial Average	0.50%	5/17/01
Master Share CAC 40	CAC 40	0.30%	1/22/01
Master DJ Euro Stoxx 50	DJ Euro Stoxx 50	0.40%	3/13/01
iShares Family
Fund name	Index	Expense ratio	Inception date
iBloomberg European Technology	Bloomberg European Investable Technology	0.50%	2/12/01
iBloomberg European Telecoms	Bloomberg European Investable Telecoms	0.50%	2/12/01
iBloomberg European Financials	Bloomberg European Investable Financials	0.50%	2/12/01
iBloomberg European Pharmaceuticals	Bloomberg European Investable Pharmaceuticals	0.50%	2/12/01
EasyETF Family