Earlier this week (on 8/25/10), the Alerian MLP ETF (AMLP) was launched.  It is the first MLP ETF product joining a lineup of five existing MLP ETNs.  I also believe it is the first ETF of any kind that is virtually guaranteed to underperform its chief competitor.

Corporate Taxes

Before buying AMLP you need to ask yourself why all the other sponsors chose an ETN package over an ETF wrapper.  The answer is taxation.  As noted in the prospectus:

AMLP is taxed as a regular corporation for federal income tax purposes and as such is obligated to pay federal and applicable state and foreign corporate taxes on its taxable income. This differs from most investment companies, which elect to be treated as “regulated investment companies” under the tax code in order to avoid paying entity level income taxes. Under current law, AMLP is not eligible to elect treatment as a regulated investment company due to its investments primarily in MLPs invested in energy assets. As a result, AMLP will be obligated to pay federal and state taxes on its taxable income as opposed to most other investment companies which are not so obligated.

In order to achieve “ETF status” AMLP had to give up its “pass through status” and be taxed as a corporation. AMLP will generally compute deferred income taxes based on the federal income tax rate applicable to corporations, currently 35%, and an assumed rate attributable to state taxes. Therefore, AMLP is required to make the following disclosure in its prospectus:

Potential Substantial After-Tax Tracking Error From Index Performance. As discussed above, AMLP will be subject to taxation on its taxable income. The NAV will also be reduced by the accrual of any deferred tax liabilities. The underlying index however is calculated without any deductions for taxes. As a result, AMLP’s after tax performance could differ significantly from the Alerian MLP Infrastructure Index even if the pretax performance is closely correlated.

Neither the AMLP prospectus(pdf) nor the Statement of Additional Information(pdf) provide estimates or examples of how significant an impact the corporate taxation will have on performance.  It is also not clear to me which state taxes will apply: the MLP’s state or the corporation’s (AMLP) state.  Don’t forget, this is taxation that occurs at the ETF level before an individual shareholder’s federal and state taxes are taken into account.

About the Fund

The Alerian MLP ETF (AMLP) from ALPS seeks investment results (before fees, expenses, and taxes) that generally correspond to the price and yield performance of the Alerian MLP Infrastructure Index.  The underlying index is comprised of 25 midstream energy Master Limited Partnerships and provides investors with an unbiased benchmark for the infrastructure component of this emerging asset class. The index is calculated using a capped, float-adjusted, capitalization-weighted methodology that results in greater diversification.

Additional information can be found on the AMLP home page, the fact sheet(pdf), and the complete list of holdings.  The claimed “Total Expense Ratio” of 0.85% appears to be misleading as it does not account for any of AMLP’s corporate taxes.

It would appear that AMLP is a roaring success, averaging more than one million shares a day for its first two days on the market.  I haven’t seen an AUM (assets under management) report, but I wouldn’t be surprised to see assets north of $20 million already.  My guess is that all the trading and assets are from shareholders that did not read the prospectus and are in for a big surprise.

AMLP vs. MLPI

UBS E-TRACS Alerian MLP Infrastructure Index ETN (MLPI) tracks the same index as AMLP with the same identical 0.85% expense ratio.  However, there will be one huge difference in their performance:  AMLP will be taxed as a corporation and the NAV will reflect a 35% withholding for taxes while MLPI will not.

For my money, MLPI is the clear choice over AMLP.  Taxation of MLPs is a difficult subject, and I do not claim to know all the ins and outs.  I am not a tax advisor, but I cannot envision a profitable situation where AMLP’s corporate taxes will be negative.  Therefore, a potentially “risk-free” arbitrage trade could be to go long MLPI while shorting AMLP – it’s just like being the tax man.

Disclosure covering writer, editor, and publisher: I am not a tax advisor.  I am not a lawyer.  All comments regarding taxes and legal issues are merely my opinions as an interested observer.  No positions in any of the securities mentioned. No positions in any of the companies or ETF sponsors mentioned.  No income, revenue, or other compensation (either directly or indirectly) received from, or on behalf of, any of the companies or ETF sponsors mentioned.

The Van Eck press release says Indian small-cap stocks are supported by one of the world’s largest and fastest-growing domestic consumer markets, with a demographic profile skewed toward the young.  India’s rapidly growing middle class is projected to triple in size over the next 15 years, making it twice the size of the entire U.S. population.  “It continues to be our strong belief that small-cap stocks are an excellent way to gain direct exposure to a country’s domestic economy,” said Jan van Eck, Principal at Van Eck Global.  “India, in particular, has exhibited demographic and economic factors that support strong continued domestic growth for years to come.”

SCIF will attempt to capture the performance of the smallest 10% of India’s total market capitalization.  Van Eck points out in the Investment Case for India Small-Caps (pdf) that this smallest 10% represents 91.2% of the total number of listed equities in the country.  The fund’s expense ratio is capped at 0.85% and the top sectors are Industrials 26.8%, Financials 20.4%, Materials 13.7%, Technology 12.2%, and Consumer Discretionary 11.8%.

There are a total of 122 holdings, with the largest being IFCI 4.7%, Sintex Industries 4.0%, IVRCL Infrastructures & Projects 3.3%, GTL 3.2%, and Nagarjuna Construction 2.8%.  The SCIF fact sheet (pdf) lists the top 25 holdings and provides a link to the complete holdings.

SCIF (summary page) will compete head-on with EGS INDXX India Small Cap ETF (SCIN).  There are more than 9,000 listed small cap stocks in India, and with SCIF holding 122 stocks and SCIN holding just 75, it is not surprising that there is zero overlap in their top-10 holdings.  The EGS fund has done a good job of attracting assets and trading volume even though the brand is unfamiliar to most investors.  This is likely to be an area where the Market Vectors fund can gain an advantage.

Both SCIF and SCIN have expense ratios of 0.85%, so the performance winner will be decided by the indexing and sampling methodology employed by each fund.

Disclosure covering writer, editor, and publisher:  No positions in any of the securities mentioned.  No positions in any of the companies or ETF sponsors mentioned.  No income, revenue, or other compensation (either directly or indirectly) received from, or on behalf of, any of the companies or ETF sponsors mentioned.

Shareholders of Grail RP Technology ETF (RPQ) or Grail RP Financials ETF (RFF) don’t have much time if they want to avoid being involuntarily liquidated.  The last day of trading will be Friday, August 27, 2010.  As always, I recommend investors sell their shares in the open market prior to the delisting to avoid the liquidation process.  Both are being quoted today with bid/ask spreads near 2% so be sure to use a limit order.

Grail decided to pull the plug on these two ETFs rather quickly.  They were part of a four ETF introduction last October from Grail and RiverPark.  Despite all the fanfare surrounding Grail’s “actively-managed” ETFs, all seven of their funds are part of the current ETF Deathwatch.

Actively-managed ETFs face five obstacles, and this batch is not the first to shut their doors.  That dubious honor belongs to Bear Stearns Current Yield (former ticker YYY) back in 2008.  The WisdomTree U.S. Short Term Government Income Fund (former ticker USY) is another actively-managed ETF that did not survive.

Disclosure covering writer, editor, publisher, and affiliates: No positions in any of the securities mentioned. No positions in any of the companies or ETF sponsors mentioned.  No income, revenue, or other compensation (either directly or indirectly) received from, or on behalf of, any of the companies or ETF sponsors mentioned.

Last Friday (8/20), a Claymore press release trumpeted the “launch” of a new ETF – the Claymore Wilshire Micro-Cap ETF (WMCR).  However, when I checked with the NYSE and Nasdaq, they informed me there were no new listings from Claymore on Friday.  A quick check of my quote screen did show a security trading with that ticker symbol, but its name was identified as the Claymore/Sabrient Stealth ETF.

Upon further investigation it was revealed that Claymore is staging another Extreme Makeover: ETF Edition.  You may recall that in late July 2009 Claymore/Great Companies Large-Cap Growth Index ETF (XGC) became Claymore/BNY Mellon International Small Cap LDRs ETF (XGC).  The result was a completely different fund with zero overlap of holdings, but with the same ticker symbol and a historical track record better than its new peers.

The current makeover is stranger in many respects.  First, Claymore changed the ticker symbol as well as the name this time around.  What was known as Claymore/Sabrient Stealth ETF (STH) on Thursday became Claymore Wilshire Micro-Cap ETF (WMCR) on Friday.  Only the CUSIP identifier code remained the same.

By changing both the name and the ticker, Claymore avoided having to close and liquidate one fund and open another.  Just a week prior, on August 13, Claymore announced it was closing four of its funds and could have just as easily made it five by including STH.  STH has been on ETF Deathwatch more than a dozen times, so no one would have been surprised to see it closed.

The second strange aspect of this makeover is that the new ETF is now saddled with a long-term below-average track record.  From its inception on September 21, 2006 the ETF has a cumulative loss of -35.9%.  Meanwhile, the primary competitor in its new micro-cap category, iShares Russell Microcap (IWC), held its loss to -25.7% over the same period.

Claymore has an “exclusive partnership with Wilshire” and is the only ETF provider using Wilshire indexes.  I don’t understand why Wilshire would allow their name to be used on a product with such a substandard track record when they could have just as easily started fresh.

I contacted Claymore for an explanation as was informed that the “critical mass” behind STH and the “cost benefits” of not having to close one fund and open another were primary reasons behind this approach.  The fund was very small before and remains small now, so the amount of money at stake is relatively insignificant and stretches the definition of critical mass.  Seeing as how the bulk of these assets are probably the sponsor’s seed money, getting shareholder approval was likely not an obstacle.

The new incarnation of this ETF will carry an expense ratio of 0.50%.  Additional information can be found on the WMCR summary page and in the WMCR fact card (pdf).

WMCR will not be counted as a new ETF and STH will not be counted as a closure in the ETF Statistics.  There was not a new listing, and there was no closure.  We will record it as a name and ticker symbol change.

Disclosure covering writer, editor, publisher, and affiliates: No positions in any of the securities mentioned. No positions in any of the companies or ETF sponsors mentioned.  No income, revenue, or other compensation (either directly or indirectly) received from, or on behalf of, any of the companies or ETF sponsors mentioned.

The article by Stan Luxenberg, On The ETF Death Watch, includes data and examples from my August ETF Deathwatch report as well as analysis on other concerns of ETFs with extremely low trading volume.

I advise all shareholders to avoid the liquidation process by selling their shares on the open market prior to the de-listing date.  Be sure to use a limit order as these funds are thinly traded.

The four affected products are:

• Claymore/Beacon Global Exchanges, Brokers & Asset Managers Index ETF (EXB)
• Claymore/Robb Report Global Luxury Index ETF (ROB)
• Claymore/Zacks Country Rotation ETF (CRO)
• Claymore/Zacks Dividend Rotation ETF (IRO)

These four funds will bring the lifetime closure count to 151, consisting of 138 ETFs and 13 ETNs.  The year-to-date number will be 27, all of them ETFs.  This is slower than the pace of the past two years; 58 products closed in 2008 and 56 closed in 2009.

A Claymore spokesman once told me they intended to keep many questionable products open for at least three years and hope assets start moving after the funds received 3-year Morningstar ratings.  The closing funds all recently surpassed their third anniversaries.

These Claymore ETF closings should come as no surprise to readers of my monthly ETF Deathwatch report, on which three of them have been consistently featured.  IRO is the one exception.   With a total of a dozen Claymore ETFs on the current ETF Deathwatch list, these four could be just the start.  Nine others to be concerned about:

• Claymore/BBD High Income (LVL)
• Claymore/BNY Mellon EW Euro-Pacific LDRs (EEN)
• Claymore/BNY Mellon International Small Cap LDRs (XGC) (note: XGC had an extreme-makeover a year ago, which doesn’t appear to have helped)
• Claymore/Ocean Tomo Growth (OTR)
• Claymore/Ocean Tomo Patent (OTP)
• Claymore/Sabrient Defender (DEF)
• Claymore CEF Index GS Connect ETN (GCE)
• Claymore U.S. Capital Markets Micro-Term Fixed Income (ULQ)
• Claymore/Zacks Mid-Cap Core ETF (CZA)

Most of these funds are aged well beyond the three years Claymore apparently extends to fledgling funds, so it is not clear what is keeping them alive at this stage.

Disclosure covering writer, editor, publisher, and affiliates: No positions in any of the securities mentioned. No positions in any of the companies or ETF sponsors mentioned.  No income, revenue, or other compensation (either directly or indirectly) received from, or on behalf of, any of the companies or ETF sponsors mentioned.

Contrary to what you might have read, USCI is not an actively-managed ETF.  The fund’s composition is not determined by manager discretion.  Instead, the holdings are determined by an index and remain static between monthly rebalancings. The prospectus (pdf) elaborates on the fact that no human bias is introduced into the process.  Even its name clearly identifies this product as an “index” fund.

That said, the index is dynamic and its composition can change significantly from month to month.  Quantitative dynamic indexes are nothing new.  PowerShares pioneered their use in the ETF space, launching more than 40 funds using this concept beginning with the introduction of PowerShares Dynamic Market (PWC) in 2003.  However, I believe USCI is the first time the concept has been used with a pure commodity ETF.

The underlying index was developed by SummerHaven Index Management LLC and is based upon academic research by Yale University professors Gary B. Gorton and K. Geert Rouwenhorst, and Hitotsubashi University professor Fumio Hayashi.   Much of the research behind the fund is documented in the 2004 paper titled “Facts and Fantasies About Commodity Futures.”  The methodology employed by the index seeks to minimize the harmful effects of contango (negative roll-yield) by favoring commodities in backwardation (positive roll-yield) and longer term contracts.

Each month 14 of the 27 eligible commodities are selected to be index components, with a minimum of one commodity from each sector (energy, grains, industrial metals, livestock, precious metals, and softs) to ensure diversification.  The monthly commodity selection is a two-step process:

1. The seven commodities with the highest percentage price difference between the closest-to-expiration futures contract and the next closest-to-expiration futures are selected (the seven displaying the most backwardation).
2. From the remaining 20 eligible commodities, the seven with the highest one-year percentage price change are selected (the seven displaying the most one-year momentum).  If all six sectors are not represented by at least one commodity, then a substitution process is employed until the constraint is satisfied.

The 14 selected commodities are included in the index for the next month on an equally-weighted basis. Due to the dynamic monthly commodity selection, the sector weights may vary from approximately 7% to 43% over time.

Selections are made on the fifth business day before the end of the calendar month.  The rebalancing then occurs during the last four days of the month, with one-fourth of the required rebalancing taking place each day.

For the month of August 2010, the fund’s sector allocation and component futures contracts are:

• Energy (14.3%): Crude Oil (WTI) SEP11, Natural Gas OCT10
• Grains (14.3%): Soybean NOV10, Soybean Meal OCT10
• Industrial Metals (21.4%): Copper OCT10, Nickel MAR11, Tin DEC10
• Livestock (7.1%): Lean Hogs DEC10
• Precious Metals (21.4%): Gold OCT10, Platinum OCT10, Silver DEC10
• Softs (21.4%): Cotton DEC10, Coffee DEC10, Sugar #11 OCT10

USCI is the latest evolution of commodity investing products for retail investors.  Phase 1 kicked-off 54 years ago with the introduction of Van Eck International Investors Gold (INIVX) in 1956.  It is currently the oldest mutual fund still in existence targeting commodity producer equities.  A plethora of similar funds arrived in the 1980s.

Phase 2 was the introduction of commodity producer ETFs, the first being SPDR Select Sector Materials (XLB) 1998.  Phase 3 is marked by the arrival of the first physically-backed commodity ETF, SPDR Gold Trust (GLD), in 2004.  Physically-backed products have been extremely successful with retail investors, but are thought to be impractical for anything except precious metals.

Phase 4 began in 2006 with PowerShares DB Commodity Index (DBC), the first ETF based on commodity futures.  Retail investors, impressed with the ability of physically backed ETFs to track spot prices, were not fully prepared for ETFs implemented with futures contracts.  The past four years have been a period of prolonged contango conditions in the commodity markets.  As such, futures indexes have greatly underperformed spot indexes, leaving many retail investors perturbed.

Now we begin Phase 5, which is marked by ETF sponsors employing dynamic indexing techniques to combat the negative effects of contango, capture the positive effects of backwardation, and maximize total return.  USCI is likely to be just the first of many such Phase 5 products as the evolution of commodity investing continues.

USCI has an expense ratio of 0.95%.  Additional information on the fund can be found in the links above and on the USCI summary page, USCI details page, and USCI fact sheet (pdf).

Disclosure covering writer, editor, and publisher:  Long GLD.  No positions in any of the companies or ETF sponsors mentioned.  No income, revenue, or other compensation (either directly or indirectly) received from, or on behalf of, any of the companies or ETF sponsors mentioned.

ELD is very similar to Market Vectors Emerging Markets Local Currency Bond ETF (EMLC), which also came out recently (7/23/10).  Both seek to own a portfolio of emerging market government debt denominated in local currency rather than U.S. dollars.  As noted in our story on EMLC, this gives investors exposure to foreign exchange risk as well as credit risk.  Whether these risks will carry a commensurate reward is not yet known.

There is an important difference between EMLC and ELD, however.  The WisdomTree ETF is actively managed.  The fund manager has flexibility to change the country weightings on short notice instead of being tied to an index like EMLC.  This could prove helpful in the event of a sovereign debt crisis tied to a particular market.

Top country weightings in ELD are Brazil, Mexico, Indonesia, Malaysia, Thailand, Turkey and Korea.  The expense ratio is projected to be 0.55%, slightly higher than EMLC, but the final yields both look like they will be similar at around 6% currently.  This is far more than can be found in developed country government bonds – which may be one reason ELD attracted significant assets so quickly.

More information can be found on the WisdomTree site’s ELD summary page.

Disclosure covering writer, editor, and publisher:  No positions in any of the securities mentioned.  No positions in any of the companies or ETF sponsors mentioned.  No income, revenue, or other compensation (either directly or indirectly) received from, or on behalf of, any of the companies or ETF sponsors mentioned.

These new offerings follow Schwab’s game plan of targeting core asset classes with extremely low expense ratios and commission-free trading for customers of Schwab brokerage.  That game plan differentiates Schwab from competitors and has worked well so far.  The firm has accumulated $1.4 billion in ETF assets since the launch of its first ETFs just nine months ago.

Schwab U.S. TIPS ETF (SCHP) will track the Barclays Capital U.S. Treasury Inflation Protected Securities (TIPS) Index with an expense ratio of 0.14%.  SCHP will face off against iShares Barclays TIPS Fund (TIP), SPDR Barclays Capital TIPS ETF (IPE), and PIMCO Broad U.S. TIPS Index Fund (TIPZ).  The three competitors have expense ratios of 0.19% to 0.20%.

Schwab Intermediate-Term U.S. Treasury ETF (SCHR) will track the Barclays Capital U.S. 3-10 Treasury Bond Index with an expense ratio of 0.12%.  No other ETFs are based on this index, although iShares and PIMCO both have funds tracking 3-7 year Treasury bonds.

Schwab Short-Term U.S. Treasury ETF (SCHO) will follow the Barclays Capital U.S. 1-3 Treasury Bond Index with an expense ratio of 0.12%.  It will directly compete against iShares Barclays 1-3 Year Treasury (SHY) with its 0.15% expense ratio and PIMCO 1-3 Year Treasury Index Fund (TUZ), which has a 0.09% expense ratio.

Disclosure covering writer, editor, and publisher:  Long SHY and TIP.  No positions in any of the companies or ETF sponsors mentioned.  No income, revenue, or other compensation (either directly or indirectly) received from, or on behalf of, any of the companies or ETF sponsors mentioned.

While the effectiveness of the strategy can be debated, the result is that short-term interest rates in the U.S. currently hover near zero.  The resulting new liquidity makes many investors think twice about investing in long-term Treasuries.  Financial markets suspect the Federal Reserve will not be shy about raising interest rates when economic growth resumes.

In other words, investors look at interest rates and say “There’s nowhere to go but up.”  This keeps some out of longer-dated Treasuries, an asset class normally viewed as a safe-haven from declining or volatile equity markets.

The problem with raising rates in a sluggish economy is that rate hikes are detrimental to growth.  Since growth in the U.S. is sluggish at best right now, inflation and rate increases may not be as big a danger as some fear-mongers would lead you to believe.

In fact, given the tame economic growth we’ve been seeing, deflation may be more of an issue.  That could mean it’s time to take a look at longer-term bonds.  The Vanguard Extended Duration Treasury ETF (EDV) is one way to exploit deflation.  We previously shed some light on the miniscule returns one can expect in money market funds currently.  EDV could be a compelling bet for investors looking to boost their fixed income exposure.

EDV tracks the Barclays Capital Long U.S. Treasury STRIPS 20-30 Year Par Bond Index.  This index includes “AAA” rated government debt with maturity dates of 20 years or more.  The average duration in the index is 26 years, which means it is supersensitive to interest rate changes.  STRIPS offer a twist on traditional Treasuries in that the interest and principal payments are separate from each other.  Yes, this is a somewhat complex play on bonds, but that doesn’t diminish the potential.

EDV’s performance on a year-to-date basis is something to behold.  While offering an annualized yield of 4.5%, EDV has also delivered capital appreciation of 15%.  That’s a stunning return for a bond fund.  Over the same period the S&P 500 is more or less flat, while previously hot niches like emerging markets are in the red.

There’s more to like with EDV.  The expense ratio of 0.14% is hardly noticeable.  Vanguard is known for its low expenses, and EDV is no exception.  That’s just another sign that EDV may have a home in your portfolio.  To use bonds for a potentially deflationary economy, go with EDV.

Disclosure covering writer, editor, publisher, and affiliates: No positions in any of the securities mentioned. No positions in any of the companies or ETF sponsors mentioned. No income, revenue, or other compensation (either directly or indirectly) received from, or on behalf of, any of the companies or ETF sponsors mentioned.