From the March 01, 2009 issue of Futures Magazine • Subscribe!

Interview with Invesco PowerShares’ Ed McRedmond

Invesco PowerShares Capital Management is a registered investment advisory firm headquartered in Wheaton, Ill., and is the advisor and sponsor of PowerShares ETFs. Many of the company’s products are on the frontier of ETF trends, including actively managed, green energy, commodity, currency and sector ETFs.

To get some insight on what’s new in the exchange-traded fund (ETF) world, we interviewed Ed McRedmond, senior vice president of portfolio strategies at Invesco PowerShares.

Q: Have expectations been met from actively managed ETFs finally getting off the ground?

A: That probably depends on who you ask. From Invesco PowerShares’ perspective I would say it’s been in-line with our expectations. We always believed that actively managed ETFs would take some time for investors to gain an understanding and comfort level, which is not really different than any new product introduction.

Unlike index-based ETFs, the actively managed ETFs do not have a historical track record that investors can look at and analyze, so investors are likely to wait and watch the product develop that track record. There’s also a perception on the part of some investors that actively managed ETFs will not provide the tax-efficiency that index-based ETFs are known for.

Time will tell, but we believe that actively managed ETFs may prove similarly tax-efficient and certainly more so than traditional actively managed mutual funds, which distributed a record amount of capital gains in 2008.

Q: What trends are we seeing in terms of leveraged ETFs, and do you think those trends will continue?

A: The growth trend for leveraged ETFs certainly continued in 2008 with about 40 new products coming to market and AUM [assets under management] of approximately $24 billion at year-end, representing a market share of about 4.8%, according to a recent Morgan Stanley report.

At Invesco PowerShares, in 2008 we launched the first leveraged and inverse products in the U.S. for commodities with our partners at Deutsche Bank. Those levered and inverse products recently had AUM of approximately $1.18 billion, and the PowerShares DB Crude Oil Double Long ETN (DXO) has seen a number of days when trading volume exceeded 50 million shares.

One thing that has become obvious with the recent market volatility is that many of the users of the levered ETFs did not really understand the mechanics and the math behind them. What I mean is that because of the resetting of the leverage – daily for the equity and fixed-income products and monthly for the commodity ETNs – there can be tracking errors over time. The daily reset of leverage will give you very close to two times up or two times down on a daily basis but not necessarily week after week or month after month if the markets are volatile. Therefore, if you are using these products, especially to hedge a position or portfolio, you need to monitor it closely and you may need to adjust your position by buying more shares or selling off shares to keep things in line.

It really goes back to one of the core themes that we at Invesco PowerShares try to preach, and that is that, investors need to closely look at the underlying index. You really need to understand the methodology behind the index to understand how it may behave in various market environments.

Q: What are some specific ways futures and options are supplement developments in ETFs, whether in the construction of ETFs or as instruments that use ETFs as underlyings?

A: Today, the majority of ETFs have options trading against them and that has certainly expanded the tools that investors can use, whether it be a covered call strategy against an ETF position, protective puts, hedging, etc. Some of the underlying indexes will also have futures contracts, all of which work together to enhance the liquidity of an ETF.

In 2007, Invesco PowerShares launched the first buy/write ETF, the PowerShares S&P 500 BuyWrite Portfolio (PBP), which is based on the CBOE S&P 500 BuyWrite Index. Then, in 2008, we launched the PowerShares Nasdaq 100 BuyWrite Portfolio (PQBW). These strategies saw a significant pick-up in interest with the market volatility in 2008, as investors looked for ways to minimize volatility while maintaining exposure to the market.

Q: In general, how have ETFs weathered the current economic storm?

A: Based on the fact that U.S.-listed ETFs saw net inflows of approximately $175 billion in 2008, of which about $74 billion came in the fourth-quarter, I would say ETFs weathered the storm quite well. There are probably a number of reasons behind this, but I think a few of the main reasons would be the transparency, trading flexibility and exposure to previously hard to access strategies like leverage, inverse, commodities and currencies.

The transparency and trading flexibility became very appealing as the markets become more volatile. If the market is moving up or down 5% intraday, do I want to wait until day’s end to know where I bought or sold my mutual funds? Does my fund own AIG, Bear Stearns, WaMu, Citi, etc.? You don’t really know if your fund is only reporting its holdings quarterly or semi-annually. With the transparency of an ETF, you know every day what you own.

Hedge funds seemed to increase their use of ETFs in the second half of the year, especially as their sources of leverage dried up during the credit crunch and the levered ETPs become one of their few sources of leverage.

Q: What new developments do you anticipate in '09?

A: I think we’ll see a continuation of acceptance and usage of ETFs among investors, especially among those who saw their mutual funds decline sharply then hit them with a capital gain distribution, similar to what we saw coming out of the 2001-02 market downturn.

We view the ETF structure as a delivery vehicle for investments, like a mutual fund or separate account. ETFs started out delivering exposure to traditional cap-weighted benchmarks, and then evolved to rules-based, research-driven index construction and now to actively managed ETF portfolios.

It will be up to investors to decide which vehicle best meets their investment needs and we at Invesco PowerShares will certainly be there to help educate them on the benefits and many ways that ETFs can be incorporated into their portfolios.

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