ETFs Flourish as Boundaries are Pushed

There is positively no shortage of exchange-traded funds to be had these days, and more inventive and narrowly focused products are emerging or in the wings.

Since the start of 2007, a flood of 109 new ETFs have been registered with the SEC, according to Sonya Morris, editor of Morningstar ETF Investor in Chicago. While the ETF market, with over $433 billion in assets at the end of February, has largely been dominated by the debut of "me-too" funds, there are some good ideas tossed in among the offerings. The challenge is for investors to separate the wheat from the chaff, she said.

It's not just the bigger providers such as Barclay's, State Street and Vanguard that are expanding their product lines, but smaller providers as well. "It seems like the smaller ETF companies are throwing whatever they can at the wall and seeing what will stick," Morris said. "They are definitely stretching the boundaries."

Earlier this year, XShares Advisors of New York reformulated a dozen ETFs it launched last year under the HealthShares brand umbrella, which now contains a total of 16 funds. The offerings read like the medical department listings at a large hospital. Among the offerings are the HealthShares Metabolic-Endocrine Disorders ETF, HealthShares Orthopedic Repair ETF, HealthShares Dermatology and Wound Care ETF and HealthShares Infectious Disease ETF. Each ETF invests in companies within a selected slice of the larger healthcare industry, although the line does include some broader ETFs, including the HealthShares European Medical Products.

While naysayers have questioned the wisdom of slicing and dicing the healthcare market into such narrowly defined segments, XShares defends its decision to take a scalpel to the industry. "We created a process of vertical investments," said Nat Wasserstein, president of XShares Advisors.

While many would look to a broader healthcare investment in which the biggest companies dominate and single-stock risk is not inherent, some very likeable small- and mid-cap stocks that might otherwise never be seen do exist, he said.

Consequently, the firm began by examining the healthcare sector, dissecting it into narrower therapeutic areas, each of which could appeal to retail investors who also have those ailments, and/or to hedge fund managers and other institutional investors, such as insurance companies, who see these as risk-management tools, Wasserstein explained.

XShares will be doing similar analytical surgery on other sectors and industries, and expects to eventually offer more than 200 ETF products, he added. "We're looking at ETFs as the dawning of a new age in financial services," Wasserstein said.

That appeal to various audiences will be important to smaller ETF providers seeking to achieve economies of scale, said Morris of Morningstar. Although institutional investors have been the ones with the most ravenous appetite for ETFs, retail investors are seeing the light. "All of the ETF providers have been trying to gain market share for retail investors," she added.

XShares has also registered 22 single-state equity ETFs, dubbed "StateShares," each of which will invest in the top 50 companies headquartered in each state. Companies with larger employee counts will be weighted more heavily. The firm has also entered into a joint venture with TD Ameritrade to offer five Independence brand-name, target-date ETFs based on indexes created by Zacks Investment Research. These funds are slated to appeal to the 401(k) marketplace, made possible through the passage of the Pension Protection Act.

Separately, XShares announced in February plans to debut products based on carbon emission credits with the Chicago Climate Exchange, the first North American greenhouse gas emissions trading system.

Further, last week XShares registered another cluster of single-country ETFs under the Wilder umbrella name, since the underlying indexes each of these ETFs will track was created by Dr. Richard Wilder. The group includes the industry's first Israel ETF, a China ETF, Brazil ETF, Latin America ETF, two emerging-market ETFs, a broad healthcare fund and a novel fund called the Wilder Healthy Lifestyle Fund that will invest in companies with revenues from diet, nutrition, exercise and fitness products.

"This may be a great sector, as everyone is trying to be healthier, and we have a weight problem in this country," said Chris Bach, founder of Symphony Wealth Management Group, advisor to the Ovation Fund, a mutual fund of ETFs.

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