Felix Salmon is sniffing around the wrong delicatessen.* He wants the ETF industry to design and launch an all-in-one fund that captures the returns on the global capital markets: To boot:
So what I’m looking for is an everything bagel: an index fund or ETF which allocates its money to all the public asset classes in the world, apportioned according to market capitalization. It would include a lot of government bonds, of course, and a smattering of index-linked ones; it would have corporate debt and subordinated debt and convertibles; it would have MBSs and CDOs and securitized credit-card receivables; it would have local-currency bonds and stocks from BRICs and from frontier markets and from all the other emerging markets too; and of course it would have a large amount of money in developed-world equities too. Add the whole thing together, and you’ll have a single investment which is as diversified as you can get: a simple, unleveraged, all-in bet on the global economy.
A worthy goal indeed. One could see how this could serve as a default portfolio for any nuber of investors. In fact, it sounds an awful lot like what CAPM theorists called the “tangency portfolio” or simply the market portfolio. The problem is that this approach is at odds with how the ETF industry operates today.
The ETF industry has evolved from one that embraced the indexing philosophy inherent in funds based on broad market indices like the S&P 500 and Russell 2000 to something altogether different. In short, big slices of the capital markets pie gave way to ever smaller slices. Felix’s portfolio in contrast represents the entire capital markets pie.
Which probably makes sense. Whatever the ETF industry is doing is working. At month end April 2010 ETF assets had never been higher and in the US stood at $830 billion according to State Street Global Advisors. The trends all seem to be working for the industry at the moment.
The market for broad-based ETFs has become pretty saturated. According to the above report there are 31 managers of ETFs in the US. More when you take a global perspective. Being the second, third of fourth entry into a segment of the ETF industry is pretty much a surefire way to lose money.What has worked historically is carving out a previously uncovered niches. For example in the last few weeks Global X has filed to launch ETFs on industries including: lithium, aluminum and fishing.
The ETF industry has done a good job of covering nearly all of the asset classes Felix mentions.** There are some notable ETF exceptions like foreign corporate bonds or local currency-denominated emerging market bonds. But the ingredients to creating a globally diversified, all-in-one portfolio are coming together.
The challenge is having the right recipe to put them altogether. James Picerno at The Capital Spectator publishes on a monthly basis the performance of what he calls the BIR Global Market Index. This index seeks to capture the returns from a global portfolio of asset classes. The amazing thing is the fact that the expenses on a globally diversified portfolio are surprisingly small.
So is the glass half-full or half-empty? In looking to capture market share ETF providers have by and large covered global asset classes. What they haven’t done is put them altogether in an easy to use, low-cost structure for investors seeking all-in-one diversification. Which begs the question why?
Maybe ETF providers are waiting for all the pieces to fall into place. (The most likely structure for a world capital markets fund being a fund of ETFs.) On the other hand maybe they don’t see the market opportunity, or that opportunity is much smaller than we realize. In either case, investors are likely going to have to wait a bit a longer for an all-in-one investment solution. The ETF industry has much smaller fish to fry.
*We apologize in advance for all the food analogies and mixed metaphors.
**Not that the ETF industry is perfect. As we have noted earlier the rush to create novel products has lead to many investors being disappointed as a fund does not perform as advertised.