Think all of the interesting international equity sectors have already been tapped? Not so fast, says Ted Pollak, founder and chief investment officer of EE Fund Management of San Francisco. His firm has created the first international equity index focused on the electronic entertainment/video game industry, which has come a long way since the industry's first, now-primitive, game Pong.

Pollak also serves as a video game research consultant to Jon Peddie Research of Tiburon, Calif., and has been a consultant to video game companies. He has assembled a board of advisors each with diverse industry expertise who help him with observations, assessments and opinions about the video gaming industry's initiatives, products, technology and costs.

Now he hopes to partner with a financial services provider and launch passive and/or actively managed mutual funds, and also an ETF based on the index.

Pollak's firm has tracked the video game industry index as far back as early 1990, although the industry traces its roots back to the 1972 debut of pioneering game maker Atari.

The market cap-weighted equity index, dubbed "eendex" as an abbreviation for electronic entertainment index, currently includes 44 companies across nine countries. Japanese video game giant Nintendo is the largest company in the index. But Pollak expects the index to broaden and evolve as new companies come into play.

The index also includes mainstream video companies Electronic Arts and Activision, as well as conglomerates Sony and Microsoft, whose market cap weightings are reduced in the index to better reflect the percentage of revenue directly tied to the video game industry, Pollak explained.

Each company in the index must have a direct line of business to the end consumer, although a sector mutual fund modeled after the index would likely include a larger universe of peripherally related companies, such as Intel whose computer chips are central to every computer game.

"The industry itself is phenomenal-strong and stable," Pollak said. That's despite the fact that trends and sometimes companies within the industry come and go. "The industry itself is always shifting as to what's popular," he notes. "But that creates pricing inefficiencies that portfolio managers can take advantage of," he added. Lumpy revenue across the industry has smoothed out over the last several years as handheld video games, casual gaming and even cell phones sporting games have gone mainstream, Pollak said.

The obvious goal is to attract video game enthusiasts turned investors who already know and love the video/computer gaming industry. According to the Entertainment Software Association of Washington, 69% of American heads of households play computer and video games, with the average gamer being 33 years of age and male. The average adult male gamer plays more than seven hours each week.

That dovetails nicely with 2006 statistics from the Investment Company Institute, the mutual fund industry's trade group, that show that half of U.S. households own mutual funds and that two-thirds of mutual funds are held by individuals between the ages of 35 and 64. Today's gamers aren't apt to go cold turkey, surveys show, and may be tomorrow's investors.

But Pollak also hopes to attract a contingent of investors who understand the financial opportunity he believes the industry offers. Perhaps that opportunity is most apparent with Vivendi's huge worldwide success of its online game World of Warcraft (known to serious gamers as "WOW"). The company, a subsidiary of entertainment giant Vivendi Universal, charges U.S. gamers $18 per month to access the multi-user interactive game via the Internet, Pollak said. There are another three million users in China, although fees differ there. Pollak estimates that the game easily generates between $924 million and $1 billion in revenue annually for Vivendi.

"It's a huge industry. Sales were greater than $12 billion in 2006," agrees Norman Young, software and video company equity analyst with Morningstar in Chicago. And while the industry has changed, he echoes, the stakes and challenges are greater.

Video game developmental costs have doubled in the last few years. It can cost $50 million to develop a game, and companies must be strong enough to withstand losses if the game doesn't catch on with the public, Young said. Add to that royalty costs that firms pay to organizations like the National Football League, high-profile athletes and celebrities for use of their name, or movie companies for tie-in games. "It's harder to have the scale to survive," Young noted.

Other hurdles also exist. The video game industry is "very cyclical," Young said. The best time to have bought video game stocks was probably nine months to one year ago. Moreover, there's a shortage of video game programmers, he noted.

This type of fund is reminiscent of those funds investing in Internet-only companies, Young added.

"Sector investing is not everyone's strategy, but it's a necessary product, in my opinion," Pollak summed up.

(c) 2007 Money Management Executive and SourceMedia, Inc. All Rights Reserved.

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