Lipper Research Analyst Tom Roseen on "Business for Breakfast" 1060 KRCN - ETF Update

A. Sure. And there has been a LOT happening.

Q. First, how big a phenomenon has this become?

A. Well, at latest count, which was March 31, there was about $340 billionof assets in about 235 funds, and both numbers keep climbing.

Q. They are NEARLY all EQUITY index funds, right?

A. True. There are only 6 bond ETFs with only about $15 billion in assetsas part of those numbers.

Q. Can you put the size of the ETFs group into some sort of context for us?

A. Right, of course! $325 billion in STOCK ETFs represents over 6% of theassets in all conventional stock mutual funds. What is perhaps morestriking is that the money in ETFs is now nearly half of the $699 billionin all INDEX funds, and index funds have been around a lot longer.

Q. What has been making ETFs so popular so fast?

A. They have several positive features that seem to be catching on withinvestors and advisors alike...

• Lower expense ratios than conventional index funds
• Greater tax efficiency due to special structural features
• Because of the lower expenses, moderately higher net cashyields than similar-asset mutual funds
• There are no loads, trailing 12b-1 fees, or early redemptioncharges etc to drag shareholder returns down
• Investors can transact in ETFs all session long, not just oncedaily after the close
• You can use all kinds of stock orders (stops, limits etc) sincethey trade AS stocks
• You can short them (and even on a downtick), which is not truefor funds or stocks.

Q. We see a lot of advertising for the so-called Spiders (ticker SPY) thatrepresent the S&P 500...

A. Right. That was actually THE first USA-traded ETF, back in 1993. Theamazing thing is that together the SPY and the IVV, another brand of S&P500 Index ETF, have now caught the long-popular Vanguard Index 500 Fund intotal assets (nearly $70 billion each). The Vanguard advantage was about 5to 1 back in 1999 !

Q. How about the range of types of assets that are traded as ETFs now, Don?

A. It seems to be expanding all the time. First it was just major,well-known indexes. But now there are lots of subcategories and styles, andof course a lot of world equity funds. As an example, the leading iSharesbrand just brought out 10 new ETFs to track more SUB-sectors of the Dowindexes. Examples are as specialized as home construction, insurance,brokerage stocks, and regional banks.

Q. So an investor using ETFs can really zero in on a specific part of themarket if they want...

A. Right. I think of that attraction of ETFs as having 2 aspects. First,what I'd call easy conceptual investing or trading. If you really like, orwant to be short, a certain part of the market because of news or megatrends, you can use them as a quick conceptual implementation.

Q. Can you give an example of that?

A. Sure. Suppose you are bullish on the general stock market but areconcerned about the effect of rising interest rates on banks or oninsurance companies' bond portfolios. Instead of being forced to buy abroad "financial services" fund, you could buy just the brokerage firms ETF(not a recommendation, just an example).

Q. And what is the second aspect you were going to mention?

A. I think an ETF helps guard you against single-selection risk.

Q. What do you mean by that?

A. OK, again by example... Suppose you like the health-care area. You couldspend a lot of time researching which one or two single stocks to buy, andmaybe miss a good piece of a quick move. Or you could agonize over whichHC fund has the best manager, low expenses, tax efficiency, or whateveryour criteria are. And in either case, no matter how much good work youdo, you COULD get unlucky and pick the wrong one going forward. So insteadyou can just buy an ETF that covers the waterfront in health care, and youavoid single-selection risk. You may not beat the market, but you will getthe index result.

Q. Are there any interesting or surprising recent developments in the ETFsarea?

A. Yes indeed! The original definition of an ETF was a basket ofindividual securities tied to some index. In the last year or more,however, we've seen several ETFs that simply tie to the prices of thingsrather than owning baskets of stocks.

Q. Examples?

A. Again, not recommendations, but...

• FXE for the value of the euro against the US$
• GLD for the price of 1/10 of an ounce of gold
• OSU for the price of a barrel of Texas crude oil
• SLV for ten ounces of Silver.
• And the sponsors say that more commodity types are in the pipeline.

A. Well, aside from muddying the definition of what an ETF actually is, Ithink they are probably good for investors and traders. Again, theyeliminate single-item selection risk (WHICH oil or gold stock?), and theyallow investors to participate in commodities areas without opening a scaryaccount with a commodities broker or maybe using very high leverage in thefutures market and getting into trouble. You may get less leverage than byowning a specific gold or silver or oil stock, but you will get the truemove in the underlying resource itself.

Q. Down the road?

A. Well, there has been talk of creating ETF classes of actively managedmutual funds that are willing to disclose their holdings constantly. TheSEC is taking a long time to look at that. But, if approved, this wouldallow the innocent LONG-term holders of the funds to avoid the highturnover (and costs) that frequent funds traders cause, which acceleratescapital gains taxes in the funds. We will need to just wait and see if itgets approved.

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Don Cassidy is a Senior Research Analyst at Lipper specializing in fund flows, exchange-traded funds, (ETFs), closed-end funds, equity fund performance, and author of Trading on Volume (McGraw-HIll).