The year 2006 was a busy one for the exchange-traded fund [ETF] industry. Almost 150 new funds were introduced. Ninety-two new funds started trading on the American Stock Exchange [AMEX] alone. It is getting to the point that it is impossible to keep track of all the new funds. In addition, thanks to recent changes in regulation, the number of new ETFs is likely to expand dramatically again in 2007.

Historically, exchange-traded funds have been used to track and trade specific benchmarks such as the S&P 500 Index ($SPX) and the Dow Jones Industrial Average ($INDU). For example, the NASDAQ 100 Index Trust (QQQQ) is the most actively traded ETF today. It holds the same 100 stocks as the NASDAQ 100 Index ($NDX), which is an index that tracks the leading companies that trade on the NASDAQ Stock Market.

Investors are active in the ETF market for several reasons. For one, since shares trade on the exchanges like stocks, the funds are easy to move in and out of throughout the trading day. ETFs can also be sold short, which is a bet that the market might decline and the share price of the fund will fall. In addition, since many of these ETFs are designed to track indexes, they have relatively low operating expenses. In the world of investments, one might say that index ETFs are cheap and easy.

ETFs were initially created to track specific indexes, new breeds of ETFs have emerged over recent years. Some of these funds use more advanced strategies such as sector rotation or portfolio tilts towards growth and value stocks. Others focus on individual sectors like biotechnology or semiconductors. Some ETFs are designed to move inversely to various market averages. In addition, a variety of new funds invest in commodities such as gold or oil.

Now, the Securities and Exchange Commission [SEC] might soon approve the first actively managed ETF. Quoting a lawyer in the SEC’s division of investment management, the Wall Street Journal reported Monday that the federal agency might “in the near future” make a recommendation regarding actively managed funds. Approval of actively managed funds would represent a major milestone for the ETF industry. It would allow a new type of ETF to begin trading—one that uses active stock picking rather than index tracking.

While it is difficult to tell whether or not actively managed ETFs will begin trading any time soon, the industry is clearing moving in that direction. Indeed, many have predicted that 2007 would be the year of the first actively managed exchange-traded fund. If so, expect a flurry of new offerings to hit the market over coming years. The number of ETFs will expand exponentially. Importantly, however, while some of these funds might seem interesting on the surface (for example, a new Elliott Wave fund that is set to debut from Xshares and Elliott Wave International Corp.), investors don’t want to lose sight of the advantages of index ETFs. Namely, they cheap and easy, which is not likely to be the case with the actively managed counterparts.


Frederic Ruffy
Senior Writer & Index Strategist
Optionetics.com ~ Your Options Education Site
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