The 20 Rising Stars of Mutual Funds 2008 - (Page 7) ETFs for Everyone Veteran industry observer and fund manager Bill Donoghue said a lot of interesting things are happening in the mutual fund industry today because more fund managers are getting in tune with what customers want and need. Still, open-mindedness needs to set in and become more prevalent. According to Donoghue, the challenge for fund managers is to drop the pre-disposed notions that what has worked in the past, such as traditional varied stock portfolios, is going to always be the best approach in the future. “ETFs really are the future,” he said. “Most advisors are still looking at them as cheap index funds because that’s all they know how to do.” “You’re supposed to not deviate from the benchmark, but you’re supposed to generate alpha. It’s really hard to do both.” — Eric Cinnamond prompted by an invitation from Treasury Secretary Henry Paulson for suggestions on how the fund industry can be changed. International investing has been an area of growth for U.S. ETFs, Donoghue noted. He pointed out, however, that only the Barclays ETF fund invests in Canada and Mexico, for example. Nonetheless, ETF funds are looking to have European counterparts. Donoghue added that regulatory limitations exist for U.S.-only strategies as well. For example, if a fund’s prospectus states that it is small-cap, then it cannot go into a large-cap strategy even if the fund believes that is the way to maximize its performance. Out of about 600 mutual fund families, only about a dozen are in the ETF business and only half of those are in it in any significant way, Donoghue noted. According to ETFtrends.com, Barclays still leads all ETF providers with more than half of all ETF assets about $325 billion. State Street Global Advisors (SSgA) follows with about $130 billion. Other leaders include Vanguard, which in December launched a trio of mega-cap ETFs that are focused on the 300 largest market cap stocks. Assets in the 612 U.S. domestic ETFs in November totaled $576 billion, which was down $8 billion from the $584 billion at the end of October, according to the most recent statistics available from SSgA. While there is a warming trend to ETFs, Donoghue pointed out that it has been slow going because they are not yet treated in a meaningful way by Morningstar’s rating process, which sees them as just a sliver of the $12 trillion in mutual fund assets. Going Global The U.S. fund industry also is beginning to look more at global investment strategies. Some believe, however, that funds are not catching on to international opportunities quickly enough and that they are limited by U.S. law from going as far as they can in the global community. The U.S. fund industry lobby, the Investment Company Institute, has acknowledged a lag in the U.S. compared with international investments by European mutual funds. In December, it wrote a letter to the U.S. Department of the Treasury stating that, in the global landscape, the U.S. fund industry share is shrinking. And it pointed to a strategy used in Europe—investing in UCITS, or Undertakings for Collective Investment in Transferable Securities—as a growth area the U.S. fund industry can embrace if it was allowed to do so. UCITS are banned under the U.S. Investment Company Act. One reason is that a UCITS approach does not require a fund company to have a board, which the 1940 law requires. The ICI request was JANUARY 2008 Compliance and performance factor into managing that portfolio and could restrict its growth. The answer, according to Donoghue, is to tell investors about international investments more and make more investments in foreign currencies. “What are they selling now? They’re selling lifecycle funds,” he said. Meanwhile, in Canada, fund companies are beginning to look beyond the U.S. for expansion. Brendan Caldwell, president and CEO of Caldwell Investment Management in Toronto, said the company will look to expand its presence overseas with more offices in different countries. The company, which now has an office in the United Kingdom, also will embrace international investments more forcefully. Becoming the Alpha Dog Alpha, based on risk-adjusted returns, and high-yield investments are strategies to which fund managers are looking ahead domestically. Funds such as UBS Asset Management’s Dynamic Alpha Fund, which this past summer beat market indices, have been successful. There are challenges, however, because the risks associated with alpha, which is common in hedge fund investing, strays from the mutual fund industry’s traditional market neutral approach. “You’re supposed to not deviate from the benchmark, but you’re supposed to generate alpha,” said Eric Cinnamond, v.p. and portfolio manager for Intrepid Capital Funds in Jacksonville, Fla. “It’s really hard to do both.” Others see a middle-of-the-road approach as the smartest direction for fund companies to take. Sandy Rufenacht, chief investment officer and principal owner of Three Peaks Capital Management in Greenwood Village, Colo., believes the future for the industry is an intermediate asset class because it has less volatility than the stock markets but is still high yield. “It’s a wide-ranging asset class,” he said, adding that it can grow massively. i MUTUAL FUND RISING STARS 7
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