The Wall Street Journal-20080204-Investing in Funds- A Monthly Analysis- Open - Shut- Hedging Bets- ETF industry joins the mutual-fund world in employing a trendy hedge-fund technique
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Investing in Funds: A Monthly Analysis; Open & Shut: Hedging Bets; ETF industry joins the mutual-fund world in employing a trendy hedge-fund technique
Full Text (794 words)Call it alphabet-and-numbers soup: The exchange-traded-fund industry is about to launch a "130/30" ETF.
The product, from ProShare Advisors LLC of Bethesda, Md., represents a move by the ETF industry into an increasingly popular category of funds that bet on share-price declines as well as gains in a bid to juice returns. These so-called 130/30 funds have been proliferating in the mutual-fund industry as small investors clamor for investment vehicles that resemble hedge funds, those largely unregulated investment pools for wealthy individuals and institutions.
Some financial pros say ETFs, which are akin to index-based mutual funds but trade on exchanges like stocks, may offer one of the cheapest ways for small investors to get access to generally pricey hedge-fund tactics, which aim to create positive returns with low volatility regardless of what the stock market is doing. The reason: ETFs are tax efficient and usually have lower expense ratios than conventional mutual funds because they are based on indexes, not actively managed by salaried stock pickers. "The 130/30 is the fastest growing, hot new thing in the market," says Matt Hougan, editor of IndexUniverse.com, a Web site dedicated to index-based investing. "This fund, by packaging that strategy into a passive product and charging what I expect to be a relatively low expense ratio and making it available to advisers and retail investors, is pushing the ETF industry to the next level."
In simplest terms, a 130/30 fund invests $100 in stocks expected to increase in value. It borrows and sells $30 worth of shares expected to fall in price, with the aim of replacing those borrowed shares with stock bought later at a lower price. The proceeds from that so-called short sale are used to buy stocks thought to be undervalued, so the fund ends up investing $130 in stocks expected to rise in price and $30 in shares expected to fall.
The goal of ProShare Advisors' planned 130/30 ProShares ETF is to mimic the performance of a 130/30 index, before fees and expenses. The fund's prospectus doesn't name the index the fund will track, give details on expected expenses or say when the fund will be available to investors, and the company declined to elaborate. The fund will use a mathematical approach to determine the quantity and mix of positions to hold to approximate the performance of its benchmark, the prospectus says. Credit Suisse Group, meanwhile, said at a panel discussion last week that it and an ETF provider plan to launch a 130/30 ETF this spring based on an index it created. Credit Suisse declined to name the provider.
Jeff Ptak, an ETF analyst at Morningstar Inc., expects the ProShare product to cost more than a garden-variety ETF because it will short stocks, but less than 130/30 mutual funds. One of the major attractions of ETFs is that they are economical, so "I wouldn't expect this particular fund to buck that trend," he says. The average annual expense ratio for a U.S. stock ETF is 0.53% of assets, while the average U.S. fund managed by a stock picker charges 1.5%, according to Morgan Stanley.
Hedge-fund-like strategies in general are becoming more popular as prospects for stock-market returns in the U.S. diminish, says Steve Deutsch, director of separate accounts and collective trusts at Morningstar.
Of the 12 mutual funds followed by Morningstar that promote themselves as 130/30 funds, nine have launched since June. And mutual- fund giant Fidelity Investments of Boston is planning to add another one to the mix in March: Fidelity 130/30 Large Cap Fund. The new Fidelity fund will use both quantitative analysis and in-depth stock research to identify stocks world-wide to buy and sell short, focusing on large companies.
"Investors overall are just looking for new solutions in an uncertain equity market with the expectation of diminished returns, so if they're not going international, they're probably looking for alternative investment strategies," Mr. Deutsch says.
The 130/30 funds follow on the heels of the growing popularity of another set of hedge-fund-like mutual funds, the "long/short" camp. They are so named because they take ownership, or "long," positions in some stocks and sell others short. Long/short funds tend to employ more freewheeling strategies than 130/30 funds, which attempt to maintain a 100% net long exposure. Morningstar counts 56 of these funds, and the average expense ratio is 2.11%.
Overall, the category has been disappointing amid the market's recent rockiness. In 2007, the average fund returned 4.6% compared with the 5.5% total return of the Standard & Poor's 500-stock index. According to Morningstar, a dozen of the 47 funds old enough to have a full-year record finished 2007 in the red.
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Ms. Maxey is a special writer for Dow Jones Newswires in Jersey City, N.J. She can be reached at [email protected].
