For a sector-by-sector outlook for 2007 and stock picks from our columnists, please click here.Exchange-traded funds experienced unprecedented growth this year, with a record 132 new products hitting the market through November, according to the Investment Company Institute. But 2007 could be even bigger, particularly if the Securities and Exchange Commission streamlines its review process for these baskets of stocks and other securities. ETFs resemble mutual funds but trade throughout the day on an exchange like stocks. Because this hybrid structure doesn't fit neatly into investment regulations, they are required to apply for "exemptive" relief, lengthening the time it takes to bring them to market. But recently, Andrew Donohue, new director of the SEC's division of investment management, has been speaking about initiatives under way to speed up the application process. Providers are also looking for ways to make ETFs available through retirement plans, which could be another huge catalyst for growth. "If we thought
While there are already a handful of ETFs that track commodities, the asset class is still relatively untapped. The first such product, streetTracks Gold Trust ( GLD), was launched in November 2004, and not long later Barclays Global Investors introduced iShares Comex Gold Trust ( IAU) and iShares Silver Trust ( SLV). More recently there's been talk about the possibility of an ETF that tracks platinum, and while this has not yet panned out, many people expect more ETFs that track individual metals and baskets of commodities to make their way to the market next year. Fixed-income markets are also relatively untapped by ETFs; there are currently just six products that track bond indices, and all are iShares. Barclays launched the first four in July 2002 and then followed up with two more, one in September 2003 and the other in December 2004. Trading baskets of bonds poses some problems, including feeding price data to exchanges from multiple sources. But Dodd Kittsley, director of ETF Research at State Street Global Advisors, said many ETF providers are working to overcome the kinks and will likely roll out some new products in 2007. Among the fixed-income ETFs currently in registration with the SEC are a batch from Ameristock Funds that are based on the U.S. Treasury indices from Ryan ALM. State Street Global Advisors and PowerShares are also said to be developing fixed-income products, among other providers.
Another growth area is ETFs that track enhanced or fundamentally weighted indices, as opposed to those that weight stocks according to their market capitalizations. These products generated a lot of buzz in 2006 when PowerShares and WisdomTree both launched ETFs based on indices that weigh stocks based on fundamentals. (The companies defined fundamentals differently, though, with PowerShares accounting for sales, cash flow, book price and dividends, and WisdomTree looking just at dividends.) Other growth areas include ETFs that use leverage to amplify the returns of an index or to move in the opposite direction of an index. ProShares already has a family of such products, and Rydex has some in registration. There will also be more products that tap into discrete market niches. Some recent examples include an ETF that provides exposure to private equity, one that tracks companies that are buying back their stock and one that follows companies with heavy insider trading. And there are some products under development, called "disease ETFs," that track companies that are developing cures for different diseases. But it remains to be seen whether any actively managed ETFs will make their way to market next year, although there are a number of such products in registration. Launching new products isn't the only avenue for industry growth, however. Providers are also trying to pull in more money for existing products by offering them through wrap accounts, annuities and separately managed accounts. But perhaps the biggest potential for growth is making ETFs available in 401(k) plans. Lee Kranefuss, chief executive of Barclays' U.S. exchange-traded funds business, says ETF providers have had a tough time breaking into the retirement market so far, which he attributes to the fact that "401(k) platforms are antiquated systems" that aren't equipped for intraday trading. It can also be prohibitively expensive for people who make biweekly contributions to their retirement plans to pay the brokerage commissions on ETFs. Kranefuss says BGI will have a strategy in place by the end of next year for getting its iShares on 401(k) platforms.