Archive for November, 2006

ETF Seed Money

The seed money is the dollar amount that an ETF Specialist firm commits to the issuer to create the initial position in the respective ETF. Some call it pay to play but I liken it more to an IPO where the Specialist is the underwriter of the new issue.

The issuer is naturally anxious to get the maximum amount of seed at the start as he is paid a fee for assets under management(AUM). The issuer has had to fund the entire birth and early childhood of the prospective ETF including legal fees for the S 1 plus accounting and a myriad of other fees. The total cost for a single ETF is substantial. Only when the seed is tendered does the issuer start to recoup his upfront expenses.

The Specialist only has the opportunity to turn a profit once the ETF starts trading. While each Specialist has a different capital cost, it is safe to say that with seed always in the millions, the interest expense is sizeable on a daily basis. The goal of the Specialist is to  sell the initial shares of the seed as quickly as possible but hopefully at something better than the Net Asset Value of the underlying securities that make up the ETF.

This situation clearly puts the Specialist and the issuer in a somewhat adversarial relationship.

Some issuers have firm upper limits on the amount of seed money asked for while others seem to go for the largest amount possible. Almost all claim to make their decision on a Specialist on a quality basis and definitely not based solely on the amount of seed offered.

As the number of ETF products has grown to roughly 300 with another 300 slated for issue in 2007, and with only 10 ETF Specialists in the game, the amount of seed money available is becoming problematic. With the proliferation of close to clone like ETFs it has become increasingly difficult for the Specialist to pick the wheat from the chaff. The end result is that there are an increasing number of situations where the Specialist is essentially stuck in a product with large amounts of seed and the consequent interest costs.

Having been brought up in a different(read older) generation, I heed the old adage that one’s word is one’s bond. Unfortunately, there have been occasional instances where some firms have not fulfilled their initial seed commitments.

The skinny is that several to many mutual fund companies are somewhere along the path to issuing their own ETFs. The obvious question is how far can the current pool of available seed be stretched? Will the mutual fund companies seed their own products? What happens to the Specialists incentive to move product if they have no seed committed? Do they jack up the offering effectively widening the gap between NAV and the sale price of the ETF?

With projections of AUM in the range of 1 trillion dollars up from the current $350 million, it seems these are questions that need to be addressed in the near term.

Recap 11-29-2006

All numbers are accumulated from American Stock Exchange Sources and or Bloomberg.

NASDAQ 10 PowerShares 9,796 shares

WisdomTree 20 products Composite volume 244,900

NYSE 204,400 83% Market share.

Claymore 5 products Composite volume 181,100 shares. AMEX 118,400 =65% market share.

ProShares Composite volume 5,525,000 shares. Primary market 1,837,200 shares=33% market share.

Rydex Composite volume 99,200 shares Amex volume 7,800=8%

VanEck 3 products Composite volume 604,200 shares. Amex volume 232,100 shares = 38% market share.

American Stock Exchange equity volume 52,934,184 shares.

Chinese Wall in an Irish American Household

During my childhood our entire family sat down to dinner 6 nights a week. We would all talk about our day. My father was an Episcopal Minister with a large parish. He always carried a large counseling load. During our dinners he would discuss various situations that had arisen over the course of his day. His discussions were always generic with no names mentioned. The result was that all four of his children were exposed to the problems of the world without having any idea as to the identities of the players.

When my two sons were growing up we continued the family tradition. Once they started playing high school sports the nightly dinners were later and shorter but we managed to sit together several nights a week. As part of my community service, I have served as the Chairman of our towns Juvenile Court. Over the past 20 years I have seen a wide variety of situations where kids under the age of 18 have strayed. Meetings were usually Tuesday nights and lasted sometimes until after midnight. Most often the next evenings dinner would include a passionate plea from me to avoid the type situations that I had sat in judgement on the previous night. On occasion, if I were truly appalled by a case, I would wake the boys up when I got home and lecture them about a case. During the entire 20 years I have never shared the names of the juveniles involved.

This Thanksgiving we continued our tradition. One son is a Tech analyst who owns half of an analyst firm called Redmonk. The other son is a PM with a large NY Hedge fund. As we talked about our various businesses I was struck with a substantial number of gaps in the flow of the conversation. Both repeatedly said that they could not discuss a multitude of situations due to confidentiality concerns. When asked what new ETF products I was looking at, I had to give them the same reply.

Interesting how life repeats itself-play it any which way-backwards or forward. Lesson well taught Dad.

PS At my younger sons 10th HS reunion last weekend several former classmates approached my son. They all asked him to send me regards and to thank me for having taken the time to blast them i

ETF Snapshot/ Tuesday Nov 27.

Amex Equity Volume 49,534,112 shares

Kellogg ETF Volume 351,900 on Amex floor.

IWB Amex Volume 9.80%. A shy light of our 10% goal.

EVX and SLX 10 Day average volume:

EVX 2,250 shares

SLX 3,480 shares

Both are showing slow but consistent growth.

Amex Market Share on Selected products:

PID Composite Vol 247,300 Amex captured 57.8%

PGJ Composite Vol 287,700 Amex captured 43.41%

PHO Composite Vol 327,000 Amex captured 45%

GDX Composite 817,000 Amex captured 30% (KCG MM traded 50,800 shares which represents 6% of the composite and 20.4% of the Amex volume).

ProFunds 12 products had composite volume of 5,525,200 shares with 36% on the Amex. Lowest composite volume for the 12 was 64,800 shares which is fantastic.

DSI-Barclay’s Socially Responsible improving with daily trades and more houses participating.

NASDAQ PowerShares products total for 10 11,976.

WisdomTree 20 products: 187,600 shares with 75% staying on the NYSE. With on floor Market Maker involvement I wonder how much higher this might be,

Claymore-5 products on the Amex. Composite volume 107,300 shares with 58% staying on the Amex.

EEB/BRIC was over 60% of this total but all five are showing encouraging volume.

Dinner

Stats and stuff in the morning. Just got in from a fantastic dinner with the folks from VanEck. They are the issuers of two of our quality products, SLX and EVX.

Those of you who have known me over the years recognize that I am not generally a night owl and that I have never used evening entertainment as a means to gain business. That being said, tonight was the second VanEck gala that I have attended in the last 2 months. The dinner was fantastic-probably a little refined and cultured for this old Irish palate-but I can still recognize quality and good taste when it is placed in front of me. I even recognized that the presentation of each dish was truly refined.

Unfortunately the variety of wines was beyond me. My taste buds are able to differentiate between Coke, Pepsi and Royal Crown Cola but little else. I am a Coke addict, only drinking Pepsi in hotels and airlines that serve nothing else. The RC is a left over from my days at Fort Benning when I received a weekly free case of RC from the local distributor in return for allowing him to place machines in the barracks in my charge. With a base pay of $202 a month, the RC was my extravagance.

Many thanks to Jan and all at VanEck. Great meal, interesting company and a very worthwhile evening. I would do it again–but only if we get more product. Of some interest was Jan’s extensive knowledge and interest in college football. Who would have thunk it.

Monday, November 27.

Better volume day. Amex equity volume 55 million shares.

Kellogg ETF volume at 384,000 shares.

Started to get a little traction on the Barclay’s Socially Responsible ETF(DSI). Still small at 1200 shares bought but 3 different houses on the buy side. Volume approaching KLD which is going active. Seems some trackers want passive not active.

Proshares continues to knock the cover off the ball.  Twelve products with a total volume of over 6 million shares with a third on the Amex which is the primary. I personally love the downside products being a natural and long term Bear. Personally long SDS and DXD.

IWB Kellogg did 16.38% of the total volume, again ahead of our target of 10%.

Claymore products continue to sell well-5 for 119,400 shares with BRIC(EEB) and HOG(CVY) leading the way. Roughly half the market share stayed on the Amex.

WisdomTree again with good volume 379,600 shares over 20 products with 80% market share staying on the NYSE.

PowerShares showing an uptick in volume in the October 12 issuance which is welcome.

Specialist Expansion to Non Amex Venues

We have been asked by several issuers to consider expanding our Specialist role to additional venues. Our current products (26 both trading and allocated) are all on the Amex. We have done a preliminary analysis and currently are seriously considering becoming a LMM on ARCA. We have eliminated the NYSE as a possible expansion. We view Hybrid as a difficult hurdle to leap. Also, our analysis indicates that the NYSE is almost twice as expensive as the Amex in terms of start up and ongoing operations. The one hurdle which stands out is that a separate BD would have to be formed as the Amex operation and the ARCA operation cannot be in the same BD. This would entail a separate management structure for the two BDs. We will keep you informed as to our progress.

Additionally, we are considering expanding our non specialist trading activities into more products. Currently we have 2 market makers on the Amex floor. We are considering adding floor Market Makers and also looking into trading ETFs remotely from an upstairs desk.