NuStar Energy ends year on a high note
NuStar Energy LP (NS)

A Close Look at Five Biotech ETFs
SPDR Biotech ETF (XBI), PowerShares Dynamic Biotech & Genome (PBE), IShares NASDAQ Biotechnology (IBB), First Trust AMEX Biotechnology (FBT), and finally the Biotech HOLDRs (BBH).

The rise and fall of America's banks
Pen-and-paper tellers to a global catastrophe: Tracing the rise and fall of US banks

Which Fund Families Have Done Best in the Rally?
Many of 2008's best performers have been left in the dust

Q: I am self-employed and fund a SEP-IRA each year. Can I open an individual Roth 401(k) as well?

What to ask your next mortgage broker?
To survive the shakeout in their industry, mortgage brokers will have to do business more transparently. A number of bills before Congress would require them to disclose fees and take on a fiduciary responsibility - that is, represent their client's best interest.

Supply and Demand
The supply of stock is mushrooming -- a bearish sign

Specialty ETFs: Are They Worth the Extra Freight?

Specialty ETFs aim to beat the market. They are strategy portfolios based on stocks screened for specific criteria. Here, Buy-Write, Insider buying, Convertible Bond, Preferred Share, Private equity, and Patent-focused ETFs are discussed.

Specialty ETFs aim to beat the market. They are strategy portfolios based on stocks screened for specific criteria. Here, Buy-Write, Insider buying, Convertible Bond, Preferred Share, Private equity, and Patent-focused ETFs are discussed. Despite their higher fees compared with plain vanilla ETFs, specialty funds deserve a look.


The concept of buy-write is that income will be generated by writing call options on underlying positions held in a portfolio. A buy-write investor captures the premium from writing call options, but is exposed to the risk that the underlying stock may be called away. Compared to naked call writing, downside is limited because the underlying position will cover the option. Buy-write portfolios tend to outperform when the market goes sideways or lower on high volatility. They do well in most other market conditions. If a market appreciates rapidly, a buy-write portfolio will underperform because the premiums received from selling calls will not cover the stock price appreciation.

The chart below compares PowerShares S&P 500 BuyWrite (PBP) with the benchmark Standard and Poor's Depositary Receipts (SPY).

With an expense ratio of 0.75%, PBP is expensive compared to the SPY, ratio 0.09%. A falling market and a VIX (a standard measure of market volatility) at 50% and higher set the stage for PBP's outperformace of the benchmark in January and February of 2008. When markets fell, the 0.75% annual premium looked trivial compared to PBP's outperformance. As the chart shows, PBP also did well initially as the market turned in March. As the market continued to rally into April and May, however, volatility fell and option premiums declined. During the sharp rally in April and May, the VIX fell from 45% to below 30%. The SPY gained 25% and PBP lagged.

Insider Buying

Company insiders have to publicly disclose when they buy and sell shares. Some investors believe that these insiders understand their products and markets better than the rest of the public, and know to buy when their stock has value. The ETF Insider Sabrient Claymore (NFO) is set up to take advantage of insider behavior. According to the Claymore prospectus, NFO tracks an index where selection is determined by "favorable corporate insider buying trends." Claymore states that earnings data is also incorporated into stock selection, as well as other criteria. Ultimately, in other words, the stock selection is proprietary but aims to take advantage of favorable insider buying trends. The expense ratio of NFO is 0.60%. The chart below compares NFO with the SPY benchmark.

Historically NFO has mostly par-performed the benchmark SPY. But in the strong rally off March 2009 lows NFO outperformed. One reason for this may be the slightly higher beta of NFO stock compared to the SPY.

Convertible Bond

One of the newest specialty ETFs is focused on convertible bonds. Convertible bonds are known as hybrids because they have characteristics of both debt and equity securities. Convertibles are in fact bonds, and pay interest coupons like bonds, but can be converted into new equity shares. The ETF representing this asset class is the SPDR Barclays Capital Convertible Bond ETF (NYSE Arca: CWB). It has an expense ratio of 0.4%, which is high for a bond fund, but reasonable for convertibles. This ETF is still too new to have a decent trading record. However, the Barclay U.S. Convertible Bond Index that the ETF tracks, because of its fixed income exposure, can be expected to outperform equity during downturns. As an example, in 2002, the SPY was down 22.5%. The Convertible Bond Index lost just 8.5%. On the way up CWB may underperform the benchmark, though probably by a much smaller margin. While the historical record of the index may provide some guidance, of the 136 names held in the index, CWB currently holds less than 40. So investors can expect some index tracking error. CWB yields about 6.5%. Average credit quality is below investment grade, at BA1.

Preferred Share

Like convertibles, preferred shares are hybrid securities between stocks and bonds. Preferred shares are similar to bonds because they typically have a specific and fixed dividend pay-out. However, they are in fact equity and thus are subordinate to bonds in liquidation. In liquidation, preferred shares and dividends owed the preferred come before common. Clearly this makes preferred stock safer and stodgier than common. But preferred stock does not appreciate based on earnings and dividend growth the way common stock does. This will slow down price appreciation of preferred compared to the common if things go well. There are several ETFs in this category. The largest is iShares S&P U.S. Preferred Stock Index Fund (PFF), expense ratio 0.48%. PFF competes with a couple of PowerShares Products: PowerShares Preferred Portfolio (NYSEArca PGX), 0.5% and PowerShares Financial Preferred Portfolio (PGF), expense ratio 0.72%. The chart below compares PFF with PGF and the SPY.

The chart shows that in the latest downturn preferred ETFs really disappointed, particularly the financial preferred fund PGF. The point of owning preferred stock is that it should be safer than common equity. Clearly, this was not true as the market sold in 2009, when preferred ETFs lagged the benchmark SPY by a huge margin.

Private Equity

Private equity refers to equity securities that are not publicly traded. This asset class is associated with leverage buy-out capital (LBO), venture capital money, and growth capital used to purchase private businesses. Private equity has a reputation for high returns because good but inefficient companies are often purchased with this money, then subsequently resold or brought public. Private equity is not subject to the same regulatory apparatus (such as Sarbanes-Oxley compliance) required of publicly traded equity. However, private equity ETFs, precisely because they are publicly traded and required to be transparent, do carry regulatory costs, that partially undo this benefit. The chart below compares the first private equity ETF, PowerShares Listed Private Equity Portfolio (PSP), expense ratio 0.71%, with the SPY.

As the chart shows, PSP got clobbered during the market downturn. One reason for this is that private equity firms tend to be highly leveraged, and thus often perform more like financial institutions than the businesses in the sectors they are operating. In this case, PSP way underperformed even a key financial benchmark, the Financial Select Sector SPDR (XLF), not shown above but down a mere 40% at it's nadir of this period. While PSP's impressive move off its March low may be attractive to traders, the volatility and underperformance of this fund in tough times should be a red flag to all but the most bullish of long-term investors.


Claymore Ocean Tomo Patent ETF(OTP) takes as its premise that intellectual property and patents are especially valuable and contribute to a company's book value in a manner not addressed by other calculations. According to this thinking, companies rich in intellectual property should outperform the markets. According to the OTP prospectus, the index follows a proprietary method of identifying "securities that offer the greatest patent value opportunities." The portfolio is rebalanced on a yearly basis. In exchange for this insight the ETF investor coughs up an expense ratio of 0.60%. What are the results? The chart below compares OTP with the SPY.

As the chart shows, OTP closely tracks the SPY. This is in some respects a disappointment as the sector mix-- heavily skewed to heath care, technology, and energy and light on financials-- would seem to favor OTP during this period. The similarity of the chart for OTP and the benchmark suggests that either the patent meme is flawed or that the Ocean Tomo index stock selection should be redeveloped. Perhaps because OTP so closely tracks the benchmark, it does not yet appear to have captured much investor interest. At around 10 million, Claymore's OTP is among the smallest funds we follow.