Sunday, April 02, 2006

Unit investment trusts and the farsighted merits of ophthalmology companies

Roger Nusbaum has been writing about recent development of tightly focused ETF's. ETF developers such as State Street, Barclay's and Powershares have been coming out with exchange traded funds that target very narrow market segments. While some people, such as John Bogle feel that these narrow index funds are strictly for speculators, I feel that they can be part of a well balanced portfolio.

The precursor to these narrow ETF's are Unit Investment Trusts offered by companies such as First Trust Portfolios. Indeed FT has recently branched out from offering UIT by launching three ETF's: the Dow Jones Microcap Select ETF (FDM), Morningstar Dividend Leaders 100 (FDL) and the First Trust IPOX-100 Index Fund (FPX). I've written my thoughts on the IPO ETF: First Trust IPOX 100 Index Fund, What is it good for?

UIT's are defined baskets of investments that sold as individual units to investors. UIT's normally charge an exorbitant sales load of 4.95% much of which is kicked back to stockbroker's in the form of incentive fee's. In order to attract investor interests UIT's often target very narrow market segments or have gimmicky investment strategies. In the ETF world Powershare's gimmick's funds: Valueline Timeliness (PIV), and Zacks smallcap (PZJ) and microcap (PZI) funds have all been quite popular with investors.

Sometimes these UIT's do cover interesting investment themes an example being the: Access Pacific Coast 101 Growth Portfolio which focuses on Californian companies. With a Gross State Product of $1.4 trillion, California is currently the largest state economy in the United States. It would be ranked the 5th largest economy in the world if it were an independent nation. California is far more impressive than Sweden (EWD) if you think about it.

Roger gave the example of ETF's proposed by Ferghana-Wellspring such as the "FW Ophthalmology Index" ETF, as being too narrow. According to Ferghana-Wellspring: "Companies in this Index are involved in the research, clinical development and/or commercialization of therapeutic agents for the treatment of various diseases of the eye including, but not limited to, age-related macular degeneration, dry-eye, diabetic macular edema, glaucoma, presbyopia and myopia, by means of pharmaceuticals, medical devices or biomaterials."

Since people dislike going blind, I assume that there will be plenty of demand for ophthalmologic lasers, intraoccular lenses (for cataracts), and drugs to treat eye diseases. Demographic trends implicit in an aging and fattening US population imply an increasing need for treatment of diabetic macular edema (from obesity) and age-related macular degeneration.

Another use of very tight ETF's is to produce portfolio's full of uncorrelated assets, and thereby gain strong diversification. For example you could combine the "FW Ophthalmology Index" with other non related ETF's such as (IGE), (PHO) and (ICF). One would assume that that the Ophthalmology sector is not correlated with Water industries, Natural Resources stocks, or Real Estate.

(FD: I own shares of PHO, and PIV)

1 Comments:

At April 03, 2006 1:01 PM, Blogger Russell Bailyn said...

Hi Market Participant,

I like your post here about the evolution of ETF's and how specific they are getting. I agree that they should be viewed more as a portfolio diversification tool than as Bogle puts it, highly speculative. I'd like to touch briefly on a point you made in a comment on my blog earlier today. I wrote about First Trust releasing the ETF "FHI," which I later realized is a closed-end fund. Upon further investigation, I've concluded that CEF's are ETF's, just not "index-based." I referenced ETF-connect which is an authority on ETF's, and they include closed-end funds as ETF's. I think the only qualification to be included as an ETF is that shares are based on market supply/demand rather than on daily NAV (like an open-end mutual fund). Please let me know your thoughts on this.
My blog

 

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