What Should Come Next In ETFs? Part Deux

Well I was not expecting a followup to yesterday's post, well not today anyway, but it is appropriate. Perhaps coincidentally to yesterday's post or perhaps not I had a conversation with a honcho at one of the ETF providers and while the conversation needs to be confidential there were a couple of broad ideas that emerged and one concept that I stumbled across that could be useful in terms of how to think about ETFs.

While we should not expect a Taiwanese Table Tennis ETF anytime soon I got the sense that the vetting of new ideas for possible funds is a very time consuming and ongoing process. That fact is great for end users. They are very concerned about bringing a fund to the market that would end up not having any utility. Obviously not every fund will end up being useful but where this one company is concerned, they do not want to waste time or money on something that has no audience.

True to the post yesterday about iShares soliciting ideas for new funds (it was not someone from iShares that I spoke with) they are open to ideas from end users and I got the sense on the phone call (so corroboration of the iShares advertising) that most providers do want this sort of input. In the course of the conversation I tossed out yesterday's idea about a frontier market financial sector ETF and while I don't know that we will see that anytime soon either I believe I am fair in saying it was not the single dumbest idea he'd ever heard.

In this context there were a couple of comments yesterday that are worth addressing. One reader professed a general dislike for country funds because so many of them are heavy in financials. The reader is of course correct that many country funds are concentrated this way. I think this circles back to a point made many time before which is that ETF is simply one way in, there are of course others. Take the example of the iShares Switzerland (EWL) which is 20% financials. As a substitute for EWL I don't think an investor would be acting reckless beyond all reason buying Nestle (NSRGY) instead. Nestle is is the largest holding in EWL at 21%, correlates to EWL quite closely most of the time but separated noticeably in 2007 during the early stages of the financial crisis.

In a given instance an ETF will be your best way in to a niche and in another instance it could be a common stock. At this point I would think investors looking to build a narrow based portfolio would expect the answer to be one or other not one at the exclusion of the other.

This leads to another point. I've been talking about a fishery ETF and the Norwegian stocks in that niche for a couple of years now. The chart to the left shows one of the names in the group in blue versus the OBX index from Norway and the PowerShares Food Portfolio (PBJ). I've talked before about why the space might generally be attractive but it is difficult for most investors to access trading (BTW Schwab offering access is less than meets the eye due to a $50 fee) and it may not be easy for many people to get comfortable buying a Norwegian fishery company. Buying Nestle (completely unrelated company of course) is going to be easier for more people than a Norwegian fishery.

It is not clear to me that a do-it-yourselfer has access to analyzing many companies in the niche and selecting one of the many tradeable choices. In that light, an ETF, should it ever list, becomes the access in terms of being cheaper, avoiding being overly exposed to some unpredictable fish illness that takes out an entire fish farm and only requires a familiarization with some large holdings not diving into what might be an unfamiliar reporting process in company filings. I have no idea what the next 12 months holds for fishery stocks but the long term theme is valid and for many people an ETF would be the only realistic shot of getting in which of course makes the a democratizing force.

Another reader commented that I was trying to hurt people because despite my saying narrow themes, he says the word narrow means thinly traded which means people are subject to tax consequences from fund closures. He seemed to imply that stocks are the only way to go. Um, if the AUM and volume are not enough for you then I doubt you would buy the fund.

No matter how useful or not that the EG Shares Emerging Market Consumer ETF (ECON) might be it would not have a long life if it had not attracted such a large asset base with trading volume so quickly. Conversely if the HealthShares Ophthalmology ETF had somehow attracted $300 million in assets on 500,000 shares a day it would still be with us. An absurdly narrow (in terms of thematic focus) fund with a lot of assets and volume is not a realistic threat to close.

In making decisions for client portfolios I have ruled out funds for having too little volume. There are existing funds that I think are a great idea but if the volume we would need to buy across the board is greater than the average daily volume, note we are a pretty small firm, then chances are I need to figure another way in. This is not that difficult; if a fund is too small for you, don't buy it.

On an unrelated note I have found a true black swan--this is the real deal. The San Diego State University mens basketball team is ranked fourth in the nation behind Ohio State, Pitt (lost last night to Notre Dame) and Duke. This is even a black swan for the butcher (readers of the book will know the reference).