Today's Wall Street Journal features an interesting piece on the relationship between fast-disappearing trading-floor "specialists" and fast-appearing new exchange-traded funds. Here are the opening paragraphs from today's story:
The rapid disappearance of stock-exchange trading floor "specialists" is starting to hurt the booming exchange-traded-fund business.
Specialists are the elite traders who, for many years, have helped maintain orderly trading amid the chaos of the floor. Now they are a vanishing breed as electronic trading gains acceptance -- the New York Stock Exchange has seen its specialists decline more than 30% since last year.
That is bad news for ETFs, which resemble mutual funds but trade on an exchange like a stock. Specialists have a unique role in bringing ETFs to market: Unlike regular stocks, which raise money through initial public offerings, ETFs historically have relied on specialists to provide "seed capital" to launch.
Within the ETF industry, the lack of specialist seed funding is becoming one of the most talked-about problems.
"It used to be if you have a good idea for an ETF, you'd have specialists competing for your products," says Morgan Stanley ETF analyst Paul Mazzilli. "Now you're begging for them" to help with seeding, he says.
Let's emphasize something important: The problem here is not with ETFs in general, and in particular not with larger, more established ETFs, which continue to enjoy the excellent liquidity, low expenses, tax efficiency, and trading flexibility that make them such attractive investment vehicles. The problem is with the rush of new entrants into the ETF space over the last year or so. And with a few hundred more ETFs on the drawing board...well, this could be a problem for funds that might have a tough time launching...and staying aloft.
We've written before (here, here, and here) on the potential problems created by the flood of new ETFs, some of which reflect the (understandable/inevitable) money-making impulse more than than sound investment logic. Today's Journal story gives us another reason to be wary of gratuitous new ETFs even as we continue to enjoy the benefits of their established predecessors.
Author, "ETFs Suffer as 'Specialists' Wither Away: Elite Traders Provide Seed Money for Funds; Seeking Alternatives," Wall Street Journal, June 1, 2007 (subscription required)