Blythe McGarvie, a former BIC Group CFO and author of Shaking the Globe: Courageous Decision-Making in a Changing World, answers questions from the Business Finance audience on the pressing finance and global leadership trends of the day. Her column, Shaking the Globe, appears regularly, touching on topics that are connecting the financial world: capital and risk, talent issues, shareholder interests, entrepreneurs, company values and decision making.
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The U.S. investment community continues to offer innovative ways to invest. Most people are familiar with mutual funds, a basket of different equities in which you can trade easily. Less people are comfortable with Exchange Traded Funds (ETFs). By owning an ETF, you can achieve diversification of an index fund and have the ability to sell short or buy on margin. You can also trade it all day long rather than at the end of the day for mutual funds. This is not the way I like to make long-term decisions, but some people prefer day-trading.
The biggest advantage of passive ETFs is that the expense ratios are lower than those of the average mutual fund. The most widely known ETF is the SPDR (pronounced Spider) which tracks the S&P 500 index. I was never a fan of ETFs when only passive indexes were available. The problem with a passive index fund is that it doesn't protect the assets in a down market. In other words, if the top 500 companies included in the Standards & Poor's index have an average 10 percent decline in their share prices, so will the SPDR ETF.
Another well known passive ETF manager is iShares with 233 U.S. listed funds according to its website. With volatility here to stay, it is more important to achieve diversification and to know what equities you are invested in. This would suggest an actively managed ETF could help CFOs and their treasurers satisfy their need. Such ETFs now exist and are quite interesting.
I recently researched the ETF industry and read the active manager WisdomTree's business overview to share with my readers. ETFs began in 1995 and reached $100 billion of assets under management in 2002. By June of 2011, assets have grown by a multiple of ten to over $1 trillion of assets under management (AUM). There are roughly 1000 ETFs in the US markets and more are added every day. ETFs compete against long-term mutual funds and represent about 10 percent market share of this $11 trillion market. In fact, the pivotal change in this investment shift occurred in 2008. The ETF industry achieved net inflows while mutual funds experienced net outflows. The ETF growth trend is continuing. So who controls these ETF families of funds?
Of the top ten families of funds, BlackRock with their iShares brand leads the list with $476 billion AUM. State Street is the second largest with the brand of SPDRs with $259 billion AUM. Vanguard is a mutual company which brands their ETFs under their own name and is the third largest sponsor with $175 billion AUM. This company was founded by Jack Bogle who was interviewed at the end of this September by Yahoo's Breakout show. He discusses ETFs and states: "The game is rigged," says Jack Bogle, the octogenarian founder of The Vanguard Group. "It is too convoluted. It is too complex. You shouldn't be playing the game. You don't need to play the game." Furthermore, "If you own the stock market for a lifetime, you get those returns. Playing games in the stock market, over every day of that time, is playing the stock market. The stock market game is rigged, the business of investing is not rigged," says Bogle. His reasoning is simple. The use of capital by companies to "develop new products, efficiencies, innovations, productivity, the improvement of consumer goods and services at lower and lower prices" is all very real and ultimately validated through earnings.
So, if Vanguard’s founder, former CEO and current President of Vanguard’s Bogle Financial Markets Research Center doesn't believe in the products, it makes one question why you should consider the investment class. (Note: Vanguard spokesperson John Woerth responded that Vanguard very much believes in ETFs as a low-cost way for investors and financial advisor (on behalf of their clients) to obtain broadly diversified exposure to the world's stock and bond markets.) There is a public company called WisdomTree which is currently the only pure play opportunity for investors to directly invest in the rapidly growing ETF market. This asset manager is the eighth largest family of funds with $13 billion AUM. I am not an investor in the fund. They have a fundamentally weighted index with emerging markets, developed world, the U.S., commodity equity ETFs and the international sector.
When checking the average annual return on investment of these funds for the last 3 years as of September 30th, the return varied by fund with their Domestic Earnings ETFs and Domestic Dividend ETFs having positive returns beating the benchmarks in 9 out of 10 funds. Their international funds did not fare so well. The point of this example is that the investment returns in the interconnected world will come from a diversified portfolio but one that you need to understand if you want to secure positive returns. Just as a tide lifts all boats, as an increasing amount of money flows into ETFs, CFOs need to consider more alternatives and where earnings are generated.
Blythe McGarvie is the founder and CEO of LIF Group, a firm offering a global perspective for clients seeking profitable growth and providing customized seminars for corporate and academic groups. A former CFO of BIC Group, McGarvie serves on several boards, including Accenture, Pepsi Bottling Group, The Travelers Companies and Viacom. Her latest book, Shaking the Globe: Courageous Decision-Making in a Changing World (published by John Wiley & Sons) is available HERE.