One Born Every Minute; As exchange-traded funds pour into the market, more of them are of dubious value. Consider the Bitcoin ETF

| SATURDAY, JULY 6, 2013

One Born Every Minute


As exchange-traded funds pour into the market, more of them are of dubious value. Consider the Bitcoin ETF. “There’s an app for that” is the mantra behind the boom in smartphones, turning them from things used just to make calls and send texts, to devices that put mobile computing in the palm of your hand or your pocket (well, almost, as screens steadily expand in size). Financial markets have seen a parallel phenomenon: “There’s an ETF for that,” for all manner of things. And, as with smartphone apps, a few exchange-traded funds dominate the market, alongside thousands of dubious offerings.The founding principle of ETFs was to provide investors seeking a stake in a market with vehicles that would trade on an exchange continuously like regular stocks—unlike traditional open-end mutual funds, which offer entry and exit only once a day at the closing price. Anybody, from multibillion-dollar hedge funds to mom and pop, and everybody in between, could get into the SPDR S&P 500 (ticker: SPY) and own the S&P 500’s stocks, paying a handful of basis points in annual fees and the price of a latte in commissions to an online broker.

As with most good ideas, Wall Street has taken the ETF to an extreme, slicing and dicing every conceivable asset class and using the familiar glutinous pasta method: “Throw a bowl of spaghetti against the wall, and see what sticks.” ETFs have spread from other, major U.S. equity market indexes, too, as with the SPDR Dow Jones Industrial Average (DIA) or the PowerShares QQQ (QQQ), which tracks the 100 biggest Nasdaq nonfinancial stocks, which represent the technology elite. So far, so good. But to pick on a random example, consider the QuantShares US Market Neutral Size (SIZ), which has drawn some $3.8 million in assets and trades an average of 70 shares a day.

At the same time, ETFs have afforded entree to markets that many investors would be challenged to find on a map. (To be clear, by map I mean a graphic depiction, on paper, of regions or countries around the world, not an app.) Markets that previously had been accessible only through local brokers in exotic locales, dealing in currencies with strings of zeros, and buying stocks in companies with unpronounceable names and opaque disclosure—suddenly were available via ETFs. Thus was born a generation of investment “tourists,” to borrow hedge-fund manager Kyle Bass’ phrase, who used this Baedeker of bourses to play markets that barely qualified for that name.

For instance, viewers of the upheavals in Cairo that filled television screens last week could readily express their views on the implications of those events via the Market Vectors Egypt Index (EGPT). The NYSE-listed ETF, whose average daily dollar volume doesn’t match the price of the average Manhattan condo, surged 16% on the week, aided by the military’s ouster (don’t call it a coup) of the Muslim Brotherhood. The investment tourists, who had applauded the “Arab spring” a couple of years ago, now figure that a semblance of order imposed by the generals is preferable.

Even more fascinating is an ETF that doesn’t even exist yet. It is a fund to speculate on the value of a Bitcoin, the supposed money that exists in cyberspace as an alternative to government-issued currencies. The ETF is a brainchild of Hans and Franz, aka Tyler and Cameron Winklevoss, the twin brothers who claimed authorship of the idea for Facebook (FB), but didn’t get the credit they said was due them. As a result, they’re merely young, handsome millionaires, instead of billionaires, which evidently really sticks in their craw. Apparently seeing Bitcoin as the next big thing (maybe even bigger than social media), they figured to cash in by—what else?—filing an exchange-traded fund.

As that perceptive observer, Stephen Colbert, pointed out a couple of months ago, Bitcoin follows in the proud tradition of made-up currencies such as Camel Cash and the euro. The viability of a monetary unit depends on a couple of attributes—its acceptability as a medium of exchange and its stability as a store of value. Leave aside the first criterion (our colleague Brendan Conway detailed on last week how Bitcoins, and thus a Bitcoin ETF, might be illegal because of governments’ scrutiny of money laundering and such). If Bitcoins had a stable value, why would anybody want to trade a derivative based on them? Just asking.

Bitcoin is an inchoate expression of a desire for a currency not manipulated by central bankers. That gold has long been such a store of value and medium of exchange seems lost in translation these days. As Barron’s alum Jim Grant has observed, gold’s value is the reciprocal of the confidence in central bankers. But, for whatever reason, the markets evidently want to believe in centrally planned currencies. Gold remains in disgrace with fortune and investors’ eyes, sliding further toward $1,200 an ounce, while gold shares were bludgeoned last week, leaving the Market Vectors Gold Miners ETF (GDX) down some 58% from its peak last year.

That the price of a Bitcoin crashed more than 50% from its peak this past spring hasn’t discouraged its fans. Nor has the proposed Bitcoin ETF been deterred by the fundamental contradiction of a liquid derivative being based on an illiquid asset. But, then again, that hasn’t stood in the way of exchange-traded funds for junk bonds or municipals, which aren’t airy notions along the lines of Bitcoins. They are real markets, but lack Big Board–traded stocks’ liquidity.

The name Bitcoin stems from a bit, the smallest unit of digital information. Bit also has monetary roots, being equal to one-eighth of a dollar, going back to the colonial period when “pieces of eight” made up a Spanish dollar. So, that’s how a 25-cent coin came to be called “two bits.”

The quarter, which was made of silver until 1964, used to be worth something. Not so much these days, because of the subsequent monetary manipulation, notably the severing of the dollar’s last, vestigial link to gold in 1971. Since then, however, there has been no credible alternative to the greenback; the U.S. remains far and away the largest economy, the pre-eminent superpower militarily, and oversees the most liquid and efficient financial system. The euro hasn’t proved to be a viable alternative. China’s yuan isn’t convertible and is only beginning to be used for international transactions on a limited basis.

The Bitcoin ETF would appear to be the apotheosis of financial alchemy, at least since the demise of triple-A credit derivatives conjured from subprime mortgages. A traded derivative based on a currency that exists only in the ether of cyberspace? Somewhere, Barnum is chuckling.

THE CONFIDENCE IN CURRENCIES, and specifically the dollar, reflects perceptions of a steadily improving U.S. economy that will induce the Federal Reserve to reduce its $85 billion-a-month bond-buying program. And after news on Friday morning of a 195,000 increase in nonfarm payrolls for June, the greenback shot up, propelled by higher U.S. bond yields.

Perhaps more important than the statistically insignificant beat of economists’ forecast of a 165,000 increase in payrolls last month were upward revisions in the two preceding months’ gains.

That’s the tally from surveying business establishments, which get the headlines. The polling of households—the source of the jobless rate that gets the attention in Washington and the evening news—showed a 160,000 increase in jobs, holding the official unemployment rate unchanged at 7.6%.

Now, card-carrying establishment economists pay less attention to the household numbers because they bounce around more, month to month. That said, Stephanie Pomboy, the maven of MacroMavens, points out that the rise in employment in the household survey consisted of a 360,000 gain in part-time workers and a 240,000 decline in full-time workers, with the rest being self-employed folks hanging out their shingles.

Taking into account those working part-time for economic reasons and not by choice and “discouraged” workers who have stopped looking for a job, but want one, the underemployment rate (U-6 to Bureau of Labor Statistics aficionados) jumped to 14.3% in June from 13.8% in May.

News of the surge in part-time employment came after the White House had announced a one-year deferral in the requirement that firms with 50 or more full-time employees provide health-care benefits to them on Oct. 1 under the Affordable Care Act, aka Obamacare.

It’s circumstantial that the hiring of part-timers, who aren’t covered by the insurance mandate, surged in the household survey, while the total of full-time workers fell. That this had anything to do with the administration’s decision to put off the employer mandate is a matter of mere speculation.

Be that as it may, the markets are assuming the Fed will begin tapering its bond purchases, beginning in September. At the same time, the European Central Bank and the Bank of England have adopted the Fed’s so-called forward guidance. Last week, they explicitly said that interest rates would remain low for an extended period, giving a further boost to the dollar.

The stock market’s focus now turns to corporate earnings, with Alcoa (AA) kicking off reporting season on Monday. As the story on page 25 details, expectations for the quarter just ended are modest, but investors are looking for better guidance for the second half and beyond. For the multinationals in the big market gauges, the stronger dollar will likely be a drag. Closer to home, a jump past 5% in the interest rate on benchmark 30-year, fixed-rate mortgages would take some steam out of the housing market, a hint of which is evident in the rollover in home builders’ stocks.

Overall, profits will point the way for the market.

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (, the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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