Rick Ferri, founder of Portfolio Solutions and the author of 'The ETF Book,' on the rise of the 'Spindex' and why 2010 will be known as the year of active ETF launches.
Active ETFs on the Launch Pad Scott Bruns: The state of ETF Market. Hi there, I am Scott Burns, director of ETF research at Morning star. Joining me today is founder portfolios solutions Rick Ferri. Rick is also the author of ETF book—has a column that he writes for Forbes online. Rick thanks for joining me. Rick Ferri: Thank you Scott. Scott Burns: Well, when we talk about to stay to the ETFs in 2010, I know there is couple of team for an area of one was in the column that you recently grown on of Forbes and you talked about these structured portfolio index note. Rick Ferri: Spendex. Scott Burns: Spendexes, I’ve got a little of choke a lot of that. I don’t want to say I totally butt in with everything but what are you kind of talking about there with the Spendex comment? Rick Ferri Well, we all have what we now in-loved as an index which prior to a lot of this product being lunch in the last few years. Indexes were measurements of bench marks of the market. It might be the stock market, might be the bond marketing and they were bench mark to measure your—how the market is doing and also how your performances doing in relation to the market. Scott Burns: They weren’t even meant to be invested. Rick Ferri: Not originally, they were not, no that is the good point and they were just meant to be bench marks. Now, what has happened to the last few years is that product providers who want to launch more than actively manage fund but what to do under an ETF structure, have to take that active management strategy and turn it into an index first. So they take the structured portfolio and they turn it into an index which I like to call a spendex, because they were not really indexes. I mean not the measurement of anything that I am measuring market performance. They are nothing that you would measure your portfolio against. There a product. There a product that has an active management product for the most part that isn’t only being called an index for the purpose of launching a product. Scott Burns: Well, you know and I looked at this and I actually I am kind of quant guy and I looked at that. I see that you know this make sense the strategy sound and I can see some of these things. Yeah, I think characterizing them as beta is definitely incorrect. But you know I do think they’re investors out there and if you like the strategy if you want to go for the alpha, I mean there is risk return, you know trade off there that this are fine product that a lot of ways to go for that. Rick Ferri: I completely agree with you. In fact, I will go step further and said that if you want kind of active management is actually less expensive to do it in the ETF than it is an open-end fund. Where I think there might be an issue is in how these things are marketed to the less educated public who thinks they are actually buying your old mom and pop index. But they are going to buy this index because it is a better index and I think that it is a little bit over done and the investor could be getting to something that they really do not want to be in. And that’s the issue. Scott Burns: Right. They don’t even understand I think and that is always the risk is that education in the first place. So, moving beyond that, when you are look at the year of 2010 and ETFs, how do you think that this year’s going to be remembered? Rick Ferri: Well, last year I thought it was the year of ETF closures and we had a lot of ETF closures to 2009. Scott Burns: At the very beginning, yes. Rick Ferri: Yes, it was quite a few. Quite a few went in there. I think the year of 2010 is going to be the year of active ETF launches. They have been trying, the estimated trying for years to expand the actively managed—well you do not have an index, it is just like a regular open-end mutual fund. Scott Burns: We like to call that traditional active management. Rick Ferri: Traditional active management Scott Burns: The idea of a manager and a team picking security. Rick Ferri: Exactly, I think this is the year where were going to see a lot of traditional active manage, ETF launches. Scott Burns: Now, do you think that is going to come from new start ups some of the existing ETF players. What do you think we are going to see a real whole sale shift from the established traditional fund management world into the ETFs? Rick Ferri: Yes, both. Scott Burns: Both. Rick Ferri: We are going to see it comes from everywhere. You know if we PEMCO come in and Tierra enterprises coming in, I think that, they are looking at this is a valuable distribution method whereas a few years ago, they were still Watching Me Industry. But it is now becoming a viable distribution method and once ETFs become more accepted in 401K plans. It is even going to get larger by more traditional mutual fund providers. Scott Burns: Even though, with the year 2010, I know you are very confident to say the year of the ETF launch. I think this is the year they are incubated and I think it is going to be really until 2013 when we start to see this three-year track records. When these funds start to have their star ratings and things like that, you know it’s where we really start to see asset gathering because that’s one thing in the media that people like “All this have failed and they have not even taken off yet” some of that is just a matter of time. That would be true if they just launch to open-end funds this year. Rick Ferri: I agree and they are really tip toeing in and we have not seen any big name managers. Bill Gross or somebody being given an ETF exclusively to manage, just as an ETF and I think that when these traditional open-end fund companies want to really step into the ETF market place. They are going to put in a very big name manage on top of an ETF and say you know the reason you want to get in to this ETF is because of this particular Morningstar manger of the year or something. And he is only managing this fund and that we have not seen yet. Scott Burns: Right. Rick Ferri: But we could. But to your point, yes, if you do not have that, then you have to wait three years to get a track record. And so, this is the year of actively managed ETF launches and maybe three years on those ETF, actively manage ETF growth. Scott Burns: We’ll see. Now, well that is all a great points. Rick as always it’s a pleasure having here. You know one thing that I am going to give a quick plug for your book here. I mean, I, whenever I have new analyst join my team, the first thing I always have them to do is read the ETF Book. It is a great, great book. You did a great job with it and I think you know anybody out there watching, who is looking to really learn more about ETFs you can find a better place to start beside Morning star and the ETF. Rick Ferri: Alright, thank you Scott. Scott Burns: I am Scott Burns, director of ETF Research. For this, another ETF commentary, please check out the ETF center on Morningstart.com and Morningstar ETF Investor Newsletter.