Interview with Barclays ETF Guru, Lee Kranefuss By John Spence February 18, 2003

Lee Kranefuss is the chief executive officer for Barclays Global Investors' Individual Investor and Exchange-Traded Products Business, where he is responsible for all of BGI's exchange-traded funds products as well as traditional mutual funds. Here he talks about how investors and advisors have received BGI's broad array of iShares ETFs, and what might be next in terms of new funds.

Q: How are advisors and investors using ETFs?

A: There's a lot of different ways people use them. Sector rotation strategies are one approach, although that's a relatively small part of the market. ETFs are also used frequently in core/satellite applications - an index core with active managers around it. The idea is to concentrate on selecting a few active managers, and not build what is essentially a closet index portfolio, with too many active managers canceling each other out at high cost. With asset allocations, investors will often use ETFs for asset classes where they don't have expertise in picking a manager, or the amount of money is too small to place due to minimum initial investment requirements.

Q: What's the difference between ETFs and HOLDRs?

A: Number one, HOLDRs are static baskets, so when companies merge or go bankrupt your basket gets smaller and smaller. There's never any rebalancing taking place. Number two, HOLDRs don't follow a known index, so you can't go back and look at the history of that particular package. With an ETF that's tied to an established index, you can at least go back and get some sense how the index has performed.

HOLDRs have a different legal structure called a grantor trust, so you don't have certain shareholder protections in HOLDRs that you do have in an ETF. For example, there's no board in a HOLDRs. Also, HOLDRs are a look-through vehicle, so you technically own all the shares, and you will get annual reports from every company in the basket. If you own five different HOLDRs each with twenty different shares, then you'll get 100 annual reports a year.

Q: A large majority of ETF assets are concentrated in the top few funds. What are you doing to expand interest outside the spiders (SPY), diamonds (DIA), and cubes (QQQ)?

A: Roughly speaking, you have about 65% of the assets in the top three funds. We often think in terms of the old model and the new model. Those three funds are all structured as unit investment trusts, and they were issued under the old idea that each one is a single hot product. If you can come up with the index that people want, you just launch it and it'll run away by itself. It doesn't require any marketing and sales, you don't need a complex website, and it doesn't require much support.

The new model in our opinion is all about trying to help people build structured portfolios, not just putting out hot baskets. If you look at it that way, the real growth in the market has been away from the three big ETFs. Last year was great for us; we had more net cash inflow than any other manager in the ETF market. We're not selling a single hot product that ebbs and flows depending on market conditions; we're selling modular portfolio building blocks.

We do a lot of work with advisors, with an eye towards educating people on what ETFs are and how to use them effectively. That's what's going to drive future growth.

Q: What's on the horizon in terms of new iShares launches?

A: The big area where we're getting a lot of interest is fixed-income. I think there will also continue to be specialized areas of interest in equities, like the South Africa iShares we just launched.

Our first four fixed-income funds have about $4 billion collectively in assets. We have three Treasury funds and one liquid corporate bond fund. There's also a lot of potential demand for mortgages, high-yield, and munis. But all of these asset classes raise new complexity issues and operational challenges that we're going to have to work through before we even file for ETFs based on them.