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Thursday, September 15, 2005

God Bless PowerShares

Reported by Theresa Sim

The blessings were plentiful during the opening of the American Stock Exchange on Thursday morning. And Bruce Bond, president of ETF upstart PowerShares, was the one dealing them out.

"God bless America, God bless the American Stock Exchange and God bless PowerShares!" exclaimed Bond, to modest cheering from the ranks of the half-empty exchange.

Bond was at the Amex to celebrate the first day of trading of three new PowerShares ETFs. He was accompanied Neal Wolkoff, chief executive officer of the exchange, Jonathan Worrall, chief executive officer of Mergent, the index provider of the new Dividend Achievers ETFs, and other watchers.

After the bell ringing, attendees of the market opening ceremony were treated to a tour of the ETF specialists' desk, Kellogg Capital -- four or five men, who mostly stood, inscrutable, behind their screens.

But as one of them explained, the specialists were taking the first orders for the new Dividend Achiever Portfolio, the High Growth Dividend Achiever Portfolio, and the International Dividend Achiever Portfolio. All of the four ETFs are based on Mergent's methodology, which limits the portfolio universe to companies that have increased their dividends for at least ten consecutive years.

Later on in a conference room above the exchange, Bond explained his strategy for the products and for the company.

The new funds, said Bond, are positioned to protect against inflation, provide growth and provide tax- and cost-efficient investing.

As for the company's own growth, Bond shied away from talking about PowerShares' goals in hard numbers, but painted a picture of the future which may frighten those in the mutual fund (and separately managed account) businesses.

Currently 90 percent of the company's sales are in the retail channel, most of which is through advisors, said Bond. He plans to continue that strategy of targeting advisors in the retail channel, who use the ETFs within portfolios. On the institutional side, Bond said that the firm is weighing its next move. "We're obviously being approached by a number of 401(k) providers we are very interested in the space," said Bond.

Bond predicts that the ETF marketplace will eventually resemble the mutual fund landscape -- 90 percent of assets in actively managed funds, and 10 percent of assets in indexes. Bond envisions that PowerShares will fall in the 90 percent group within the ETF universe, while strictly indexed-based ETFs like iShares will be relegated to the 10 percent slice.

Of course, the numbers don't stand that way now. But why might they, according to Bond? For one, advisors have to prove their value-add, and with vanilla indexed-ETFs, they have a harder time doing so. "Advisors are not comfortable selling a benchmark," said Bond.

On the other hand, "PowerShares are a value-added product," said Bond, who concedes that educating advisors about the types of ETFs remains a challenge.

Bond has a point, there. With all of the hoopla surrounding actively-managed ETFs, is the industry missing the point that actively-managed ETFs already exist, to a degree?

After all, the original intent of an investing in an index was to sit out of the picking game and accept the theory of efficient markets. This is not the case when it comes to these selective funds. One of the newly launched Dividend Achievers currently includes just 312 companies. From 1983, that universe has remained fairly narrow -- from 280 to 420 companies, according to Kevin Heckertt, equity research manager at Mergent. On average, those companies stay in the universe for 22 years.

The inclusion or exclusion of companies in the index, like other indexes, is strictly objective and rules-based. So there's no discretion involved, but these products are also not just capturing the broad market, either.

Bond also maintains that PowerShares will hold their own against separately managed accounts, even if the minimums do move down. That's because as their minimums decrease, they become more like a mutual fund, said Bond. He adds that once funds, ETFs, managed accounts and other products are compared on an after-tax basis, ETFs will look very favorable.  

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