BUSINESSWEEK ONLINE : APRIL 24, 2000 ISSUE
BUSINESSWEEK INVESTOR Funds That Trade Like Stocks Flexible ETFs can be bought on margin or sold short David Soltis is an active technology investor in Doylestown, Ohio, whose stocks can move 50% or 60% in a few days. To smooth out some of that volatility, Soltis last fall moved a portion of his portfolio into Cubes, shares of a Nasdaq 100 index fund that trades on the American Stock Exchange under the symbol (QQQ). Even after the Nasdaq's recent bungee-jump gyrations, Soltis, 21, still sees the Nasdaq 100 as the best broad play on the New Economy--and a better deal than conventional mutual funds. With Cubes, he says, ''I can do everything I can do with a stock, like buy them on margin or sell them short.'' Cubes and similar funds such as SPDRS, or ''Spiders,'' which track the Standard & Poor's 500-stock index as well as nine index components, and ''Diamonds,'' which follow the Dow Jones industrials, are some of the hottest investment products on Wall Street. Known generically as exchange-traded funds (ETFs), they marry the simplicity and efficiency of index investing with the flexibility of stocks. Their expenses are competitive with index mutual funds. But unlike mutual funds, you can trade them all day long. Of course, these are not the only funds that trade like stocks. Closed-end funds, most of which trade on the New York Stock Exchange, have been around for decades. The main problem with closed-ends comes when investors want to cash out. The price they'll get is usually different--often lower--than the value of the fund's portfolio. These newer ETFs attack that problem effectively. Most are either index funds or baskets of stocks that, once selected, don't change. This factor--along with marketmakers' ability to create and redeem shares to meet investor demands--allows the market price of the funds to trade very closely to the net asset value of the underlying portfolio. You can choose from some 37 ETFs, which include more narrowly defined sector funds and country-specific portfolios known as World Equity Benchmark Shares (WEBS). Though ETFs have been around since the 1993 birth of the Spiders, they've only really caught on in the past few years, benefiting from the popularization of index investing and rock-bottom brokerage commissions. The total assets in the S&P 500 ETF are now $17 billion, and the entire ETF universe is less than $40 billion, while the Vanguard 500 Index Fund alone stands at $100 billion. But the number of ETF offerings could swell later this year when Barclays Global Investors gets regulators' O.K. to launch some 62 new funds. Some will track market sectors such as the Internet and real estate operating companies, while others will track a variety of value and growth indexes. Even more ETFs are in the works. John Nuveen Co., a major player in closed-end bond funds, recently hired Gary L. Gastineau, who developed ETFs for the American Stock Exchange. His mission: develop ETFs for Nuveen. The Street is abuzz with talk that Fidelity Investments is working on an ETF clone of one of its big funds. If so, it would be the first actively managed ETF. Because ETFs are very liquid, ''they are a great way to ride the market's momentum,'' says Ken Wolff, who runs a day-trading Web site, Mtrader.com. Wolff likes to trade Internet HOLDRs--ticker symbol (HHH)--a product from Merrill Lynch & Co. that is based on a basket of 19 Internet stocks, from giant Yahoo! (YHOO) to tiny EarthLink (ELNK). ''Yahoo, eBay (EBAY), and Amazon.com (AMZN) will jump quickly,'' says Wolff. But because HHH is a portfolio of companies and doesn't move as much, ''you still have time to buy the HOLDRs.'' Wolff also trades the Biotech HOLDRs (BBH). Funds such as HOLDRs will never perform as well as its best stocks. But they have some advantages, especially compared with playing specific stocks in such high-risk sectors as the Internet and biotechnology. With ETFs, Wolff adds, ''you don't have to worry that one of your companies is going to blow its earnings report, the stock will halt trading and open down 50%.'' ETFs are not just for the quick trade. Gastineau says longer-term investors--including institutions--are starting to use them to put cash to work while they hunt for individual stocks. For example, in the mid-1990s, investment manager Thomas S. Mench of Mench Financial in Cincinnati began using ETFs in the portfolios he runs for individuals and small institutions. As the menu of ETFs expanded, he has largely moved to using all-ETF portfolios for the $130 million he now manages. ''About 92% to 95% of what you earn is determined by asset allocation, not stock selection,'' says Mench. ''ETFs are all about asset allocation--U.S., foreign, large-cap, small-cap.'' Just look at Mench's sample portfolio (table). It's one he might use for an investor aged 35 to 55 and willing to take on moderate risk. For a $500,000 portfolio, he allocates approximately $48,000 each to 10 ETFs, leaving a 4% cash cushion. For the U.S. diversified portion, he uses the S&P 500 and S&P 400 MidCap Spiders. ''I've used Cubes in the past, but I think the Nasdaq's valuation is too high now,'' says Mench. BALANCING ACT. He's not afraid of technology, though. Instead of the Cubes, he's investing in the more moderately valued S&P Technology Spider, as well as Spiders tracking four other sectors--consumer services, energy, financial, and industrials. Sector Spiders, all based on components of the S&P 500, allow him to increase bets on areas of the market he expects to outperform. For overseas exposure, Mench uses WEBS for Germany, Japan, and Mexico because they look attractively valued and provide regional balance. In assembling an ETF portfolio, it's difficult to start with exactly equal allocations. That's because unlike mutual funds, there are no fractional shares. For ease of execution, Mench also rounds out his ETF trades to multiples of 10. So in this portfolio, he has 320 Spiders instead of 317. HOLDRs, however, trade only in multiples of 100. The reason Mench doesn't use them is that he prefers ETFs that track standardized indexes. One attraction of Spiders, Diamonds, and Cubes is that they're based on some of the world's most widely followed indexes. Glance at cable TV news or most news Web sites, and you know exactly how your investments are doing. By JEFFREY M. LADERMAN _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ BACK TO TOP					RELATED ITEMS Funds That Trade Like Stocks TABLE: Exchange-Traded Funds TABLE: Inside an ETF Portfolio INTERACT E-Mail to Business Week Online

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