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May 7, 2012 EXCHANGE-TRADED FUNDS

Talking About ETFs

A longtime analyst has advice for individual investors
By ARI I. WEINBERG

For the past 15 years, Deborah Fuhr has spent her days deep in the weeds of exchange-traded funds. As an investment strategist at Morgan Stanley and then global head of ETF research at ETF sponsor BlackRock Inc., she observed as the industry grew from a few funds with a couple billion dollars in assets to more than 1,000 products with more than $1 trillion in assets. More in Investing in Funds
How to Play the Bond Market Now Time to Limit Access to Leveraged ETFs? Fund Dividends: Better to Reinvest or Not? Competing Designs for Stock-Picking ETFs A 'Preferred' Option for Income Investors Read the complete report

In February, six months after leaving BlackRock, she co-founded London-based ETFGI LLP to educate and advise institutions on the nuances and uses of ETFs and asset allocation. Ms. Fuhr sat down with The Wall Street Journal to discuss her perspective on the fastest-growing market for investor assets. Here are edited excerpts of the conversation:

Unstoppable Growth?
WSJ: Over the past few years, the growth of ETF assets has seemed inexorable. Is there anything on the horizon that could change that? Ms. Fuhr: The growth of ETFs will continue simply because the types of exposures that you can use ETFs for are large and growing. For example, ETFs have allowed investors to get access to markets in Korea, Taiwan or India that are difficult to enter in a very efficient fashion. Another benefit that will continue to spur ETF asset growth is cost. Advisers and individual investors get access to the very same toolbox as institutional investorsin breadth and depth of countries and sectorsat the exact same annual cost. WSJ: Could a market disruption put the brakes on growth? Ms. Fuhr: Although bond ETFs have grown significantly in the past few years [offering an alternative to stock portfolios], a repeat of the financial crisis could flush money out of ETFs and into bank accounts and other safe products. WSJ: Will actively managed stock ETFs take off? Ms. Fuhr: It depends on how you define active management. Of ETFs structured as mutual funds, only 37 of 1,154 are active in the traditional sense of a portfolio manager picking stocks, bonds or ETFs. They

represent less than 1% of assets. If you could consider ETFs based on non-market-cap-weighted indexes as a form of active management, then it is actually much larger. WSJ: Focusing on traditional stock picking, do you expect a significant migration of actively managed mutual funds to active ETF form? Ms. Fuhr: No. If we think about an active manager making concentrated bets on a limited number of stocks, he won't feel comfortable with an ETF given the requirements for daily transparency. It would be like your grandmother giving away her secret sauce. Plus, when you look at how institutions investbased on three-year track records and [using only] funds with over $100 million in assets you've got a chicken-and-egg problem given the current size of active ETFs.

Investor Knowledge
WSJ: Over the 15 years you have been following ETFs, what has surprised you?
Graham Tonks

Analyst Deborah Fuhr has followed ETFs from their early days

Ms. Fuhr: I was most surprised in the early days by how many people were holding ETFs with no idea in what they were actually investing. I would talk to institutional investors about SPDRs and QQQ, but they thought they were just holding securities as opposed to actual funds. Surprisingly, that need for education continues today and is actually getting greater. Many investors now know what ETFs are, but until they decide to use one, they don't ask enough questions to be comfortable. WSJ: Do individual investors and advisers know how to trade ETFs? Do they hurt themselves in how they do it? Ms. Fuhr: Most ETFs that individual investors or advisers should be using are large and liquid, so they can buy them safely without affecting the market.

Deborah Fuhr, partner at ETFGI, talks with WSJ's Ari Weinberg about the differences between exchangetraded funds and notes, plus she explains some of the ETF products that can help track commodities.

But when you start to consider exposures in niche markets, you or your adviser need to be very clear about how much you should be buying and holding and whether your trade itself could affect the market for the ETF and the underlying securities. As a general rule, never trade more than 20% of average daily volume. For an ETF that doesn't trade, you could be it. Just because there is this huge toolbox of products, not all of these products are appropriate for all investors. And just because a new one comes to market doesn't mean you should change [your holdings]. WSJ: I'm an ordinary individual investor. What should I know about ETFs that I probably don't? Ms. Fuhr: Make sure that you know and understand the benchmark that the product is designed to track. Products with similar names can be based on market capitalization, equal weighting or some other indexing methodology that can deliver very different returns than what you expected. But you should also be careful about non-fund exchange-traded products that weren't originally designed with the retail investor in mind and that use structures that don't have diversification requirements and other protectionsfor example, single-exposure commodity funds, like SPDR Gold or funds that look to get exposure to oil through the futures market. Issuers have moved beyond the fund structure to offer products that imply different risks, different tax

[treatment], regulatory requirements and performance and costs. Mr. Weinberg is a writer in New York. Email him at reports@wsj.com. A version of this article appeared May 7, 2012, on page R4 in some U.S. editions of The Wall Street Journal, with the headline: Talking About ETFs.

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