The innovative exchange is seeking a patent for a “black box” that will power the next new product line: actively managed funds that trade like stocks
The stock ticker at the American Stock Exchange in New York these days
displays a repetitive string of “Spiders,” “Diamonds” and “Cubes.” To the casual observer it appears that SPY, DIA and QQQ are the hot stocks of the moment. Actually, they are exchange-traded funds (ETFs), representing baskets of stocks in the Standard & Poor’s 500, Dow Jones Industrial and Nasdaq 100 stock indexes, respectively.
ETFs, which look like index funds but trade like stocks, account for about 70% of the volume on the Amex, which introduced the hybrid instruments to the US market in 1993. Now that ETFs have become the fastest-growing asset class in the money management industry, the New York Stock Exchange and many other markets around the globe, electronic and otherwise, are jumping into the ETFtrading business.
The Amex, whose motto is “Constant Innovation,” is none too pleased to see others elbowing in on a product it spent a lot of time and money to develop.“I am very angry about it,” says Salvatore Sodano, the exchange’s usually soft-spoken chairman and CEO. Rather than being flattered by all the imitation, Sodano says he and the Amex have learned a lesson from the experience. “We are seeking a patent for technology for exchange trading of actively managed funds, which we expect to be the next big development in the ETF industry,” Sodano says.“We have developed a ‘black box’ that will enable intra-day pricing of these funds, and we won’t license the technology to anyone else,” he adds.
With actively managed ETFs, an investment adviser actively selects fund holdings to generate performance instead of simply matching a benchmark index. The Amex chairman says he expects the Securities and Exchange Commission to approve trading of actively managed ETFs in the next 12 to 18 months.“We have developed a quantitative approach that should allay any concerns the regulators may have about intra-day changes in an actively managed portfolio being relayed immediately to market participants,” Sodano says.
Pointing to a clutch of photographs on his office wall showing himself posed with the heads of exchanges in Europe and Asia (as well as one with the Pope), he remarks, “ETFs have put the Amex on the global map.”A joint venture with the Singapore Exchange allows investors to buy or sell some of the same ETFs in Singapore as in the United States.The Amex also listed the first US equivalent of an ETF on the Tokyo Stock Exchange, and it reached agreements with Euronext and the TSE on trading of each other’s ETFs.
Looking for Diversification
In November last year the Amex signed a marketing agreement with FTSE Group, a global index company, to promote the creation of ETFs for the US market. FTSE and Amex ETF Services will work together to identify potential sponsors that will create ETFs, based on FTSE indexes, which will be listed for trading in the United States. Brooklyn-born Sodano says this is the latest example of how the Amex has always looked for ways to bring new diversified investment opportunities to investors.
Earlier this year Sodano was appointed to the FTSE/Xinhua Index Committee, which oversees the FTSE/Xinhua Financial Network series of Chinese indexes.“Small and mid-size enterprises account for 98%of the growth in China,” Sodano says.“And smaller companies are a sweet spot for the Amex.” The Amex Composite Index has outperformed other leading indexes in recent years, he says, because it comprises new growth-oriented companies with the best chance of succeeding.“We have an equal distribution of companies and are not weighted toward technology,” Sodano notes.“We also have some very big companies listed on the Amex.”
The Amex says it is the only primary exchange that offers trading across a full range of equities, options and ETFs. It is the second-largest options exchange in the US, and on some recent days it has been the largest, Sodano says.The Amex trades 35 options on ETFs.
Sodano is a man of many hats, but he may soon be doffing one of them. He says he likely will step down as vice chairman of the National Association of Securities Dealers after the NASD gives up its ownership of the Amex. “I spend most of my time at the Amex already,” he says.The NASD, meanwhile, has largely divested Nasdaq and plans to focus in the future on its core mission as a regulator.
The American Stock Exchange currently lists exchange-traded funds on 121 broad-based, sector and international indexes. These ETFs are designed to provide investment results that correspond generally to the price and yield performance of their related indexes.
This new class of securities has grown to more than $100 billion in assets in less than a decade. Here are some of the most popular ETFs:
THE NASDAQ-100 INDEX TRACKING STOCK. Trading under the ticker symbol QQQ, and known as “cubes,” this is consistently the most-active issue on the Amex. The ETF is a basket of securities representing 100 of the largest compa-nies listed on Nasdaq.
STANDARD & POOR’S DEPOSITORY RECEIPTS, or SPDRs, are unit investment trusts fixed at 1/10 the value of the S&P; 500 index. Separate “spiders,” as they are dubbed, also exist for different industry sectors of the S&P; 500. The SPDR that tracks the S&P; MidCap 400, for example, trades under the symbol MDY.
THE DIAMONDS TRUST fund tracks the Dow Jones Industrial Average and trades under the symbol DIA. The value of the ETF is approximately 1/100 of the value of the DJIA.
iSHARES RUSSELL 2000 GROWTH INDEX is one of the more-active ETFs from Barclays Global Investors. This ETF tracks the Russell 2000, a small-cap bench-mark comprising the 2,000 smallest stocks in the Russell 3000.
Source: American Stock Exchange
Nasdaq Stocks Go on the Block
The Amex is reviewing its strategic alternatives and plans to make an announcement regarding its independence from the NASD in the near future. Sodano says the Amex is not considering any kind of a tie-up with the NYSE. In August the Amex began trading Nasdaq securities on the same floor with underlying options in these securities. This enabled investors for the first time to trade Nasdaq stocks using the auction style of trading.
Meanwhile, the Amex is racing to stay at the head of the rapidly expanding ETF pack. In June 2002 it began trading the first fixed-income ETFs, four iShares sponsored by Barclays Global Investors.On November 1 New York-based ETF Advisors began trading four new bond ETFs on the Amex that are pegged to most recently auctioned treasury securities.
Clifford Weber, senior vice president in charge of the Amex’s ETF Marketplace, says the new bond ETFs offer investors the opportunity to develop a diversified portfolio of ETFs that reflect their chosen asset-allocation preferences.“They offer another layer of value to add,”he says. The Amex also plans to offer inverse ETFs, which move in the opposite direction as the index on which they are based.
Competition Gets Hotter
While the Amex lists and trades 125 ETFs, more than any other exchange, the competition is heating up. Fresco Index Share Funds, sponsored by UBS Global Asset Management,launched two new ETFs on the NYSE in October 2002 based on the Dow Jones Stoxx 50 and Euro Stoxx 50 indexes.“These blue-chip indexes are the most widely recognized proxies for the European and eurozone markets, respectively,” says Scott Stark, Zurichbased managing director of Stoxx, a joint venture between Deutsche Börse,Dow Jones, Euronext Paris and SWX Swiss Exchange.
Of the 50 constituent stocks in each of the two indexes, 48 trade in the US either as American Depositary Receipts or global shares. Stark says that because the ADRs trade on the NYSE,it made more sense to trade the ETFs on the Big Board instead of the Amex. Eurex, the derivatives market operated by Deutsche Börse and SWX, began trading options and futures on ETFs last November. The exchange says the new products offer tailor-made hedging opportunities for the underlying ETFs.
OneChicago, meanwhile, signed a licensing agreement with Dow Jones to offer futures contracts on the Diamonds ETF. OneChicago is a joint venture of the Chicago Board Options Exchange, Chicago Mercantile Exchange and the Chicago Board of Trade launched last month. It expects the new futures to be an important hedging tool for the Diamonds options and Dow Jones Industrial Average futures contracts listed at the CBOE and the CBOT. The Diamonds futures contracts will be physically settled at expiration and can be traded out of either a securities or a futures account.
By Gordon Platt