Wall Street Journal Article June 5, 2000 Tradable Shares Bring Some Buzz to Mutuals By AARON LUCCHETTI Staff Reporter of THE WALL STREET JOURNAL Michael Parness, a day trader who operates out of New York City's Tribeca district, is looking for what he calls "big dramatic moves" as he kicks his legs up on an L-shaped desk and monitors the Nasdaq Composite Index on a computer screen. "That's the only time it's worth playing them," he says, referring to one of the trendiest investment products around, the Nasdaq 100 Tracking Stock. Several states away, Thomas Mench, a Cincinnati investment adviser, ponders whether to shift his investors' money back into the Nasdaq-100 shares, as one of many market-timing moves he takes over a period of weeks. And 600 miles away in Charlotte, N.C., homemaker Ann Jones is sitting tight, despite many down market days, on the purchase of the Nasdaq-100 shares she made 14 months ago. Some say they're the latest, greatest investment gadgets. And with $40 billion in assets, even most detractors grant that they're starting to reshape the world of index mutual funds. "They" are exchange-traded funds, or ETFs. And a look at three investors in the $11 billion-in-assets Nasdaq 100 Tracking Stock, among the most popular of the new breed, sheds light on the appeal they hold for individuals -- and the threat they pose to the traditional mutual-fund industry. These new funds seemingly could have been spooned out of an alphabet-soup can: SPDRs, iShares and QQQs (the shorter alias of the Nasdaq-100 stock). But what are they, exactly? Unlike mutual funds, which can be bought only at a price set at 4 p.m. Eastern time each trading day, tradable funds can be bought and sold at market prices throughout the day, just like a stock. They tend to have lower costs than their conventional cousins because the asset-management firms that sponsor them don't deal directly with investors; securities brokers and financial advisers pick up the slack. For some investors, tradable funds don't make sense. For instance, commissions paid to the brokers and advisers eat deeply into the returns of those investing small sums. Another drawback: Even though Barclays Global Investors is rolling out 40 new tradable index portfolios, funds that use professional stock pickers to identify holdings aren't available yet. Also, the newish products remain untested in periods of intense market stress. Still, fund firms are closely watching the growing interest in this new investing vehicle. Indeed, mutual-fund behemoth Vanguard Group last month filed to add tradable-share classes to five of its most-prominent stock-index funds. And about a half-dozen mutual-fund companies are exploring versions that would be headed by stock pickers, a senior official with the American Stock Exchange told a big industry conference several days after Vanguard's announcement. Tradable shares were pioneered and most are traded on the Amex. Still, it isn't entirely clear whom the tradable funds appeal to -- those who would ordinarily invest in mutual funds, or those who otherwise would buy hot stocks. There is a lot of evidence that the latter are among the biggest holders of the Nasdaq-100 stock. Exhibit No. 1: The average holding period for an investor is a mere three days, according to numbers crunched by Bogle Financial Markets Research Center in Malvern, Pa. That means, on average, the entire investor base of the Nasdaq Cube (another alias for the Nasdaq-100), changes more than once a week. Investors hold on to other tradable funds a little longer, at least 10 to 30 days, according to Amex officials. The Nasdaq-100 fund appeals more heavily to hyperactive individual investors, the thinking goes, because the index itself is among the most volatile. And the number of such trigger-happy investors may be smaller than the turnover suggests, boosters say.Still, the typical mutual fund is owned for about 400 days, a significantly longer period. "These are not long-term investors" going into the tradable funds, argues John C. Bogle, Vanguard Group's founder and former chairman. It is "not your father's index investing," agrees John Roberts, head of marketing for Barclays's asset-management unit, but officials at the company dispute that the funds don't draw large numbers of long-term investors. Neither side is wrong, really. In fact, Messrs. Parness and Mench and Mrs. Jones -- the three users of the Nasdaq-100 product -- demonstrate that tradable-fund followers are an eclectic crowd. 'Die, You Dog!' Just 10 blocks from the Amex trading floor, Michael Parness, the Tribeca daytrader, discovered the Nasdaq-100 fund and started trading it last spring. One morning this past March, tech stocks slide as Mr. Parness, a bald, husky bachelor, sits in his dimly lit second-floor apartment. The Nasdaq Composite Index, from which the Nasdaq-100 index of big companies is culled, drops 100 points. Sensing a rebound, Mr. Parness, 36 years old, quickly taps his keyboard and buys several thousand shares of the Nasdaq-100 stock. In the afternoon, the index bounces back, and Mr. Parness pockets a few thousand dollars. "I go the opposite way of the market opening," he explains, reading chat-room messages as he speaks. Often wearing little more than black underwear, the former bartender and baseball-card dealer sometimes buys and sells stocks 100 or more times a day. Meanwhile, on his Web site, trendfund.com, Mr. Parness, as "Waxie," shares an opinion on any stock that's moving. On another day, in early April, Mr. Parness keys in an order for his million-dollar-plus portfolio to sell short 2,000 shares of the Nasdaq-100 stock -- essentially, a bet that tech stocks would fall. This is something that can't be done in a run-of-the-mill mutual fund. "I don't get attached to any stock," says Mr. Parness, his eyeglasses reflecting the stock quotes on his blinking monitor. At this moment, Mr. Parness is hoping an upward move in biotech stocks will be short-lived. As he sells more, his eyes dart between Web pages and news reports. A gray mouse scurries across the hardwood floor, disappearing behind the computer's hard drive. Oblivious to this real mouse, Mr. Parness bemoans, to hundreds of Web onlookers, the stocks that are rising. "Die, you dog!" he begs of one particular stock. A few hours later, with biotechnology stocks still lifting the Nasdaq index, Mr. Parness quits his Nasdaq-100 bet, cutting his losses. "It's days like this you wish you didn't trade," he says. "My philosophy is, take small losses and big gains." Closing out the losing position, he writes to the chat-room audience: "That's what you get for being a day trader." 'I'm a Little Atypical' Thomas Mench, the investment adviser, is one of the biggest boosters of the new products, but for reasons far different from Mr. Parness's. Mr. Mench started using tradable shares when the oldest one was introduced in 1993 (tracking the S&P 500 index) and brags that he has tried out most of the 45 tradable funds currently available. He has about $75 million of client money invested in the products. Mostly, he uses them in the portfolios he builds for pension funds and wealthy clients. "Our primary use of them is to create diversified asset-allocated portfolios for long-term investors," he says. While Mr. Parness is focused on hourly, and even minute-by-minute, moves in the tech world, Mr. Mench is interested in moves across a wide range of sectors that last a few weeks or longer. In January, for instance, Mr. Mench moved his clients out of the Nasdaq-100 stock and into ones specializing in utilities and energy. Recently, he has also shifted country allocations in international portfolios using various funds. Depending on the investors' sensitivity to changes, Mr. Mench tweaks the portfolios monthly or weekly. "They're very transparent," Mr. Mench says of the tradable funds, meaning that he knows exactly what stocks his clients are exposed to because they are indexed based. He also likes the lower expense ratios; Barclays iShares S&P 500 Fund has an annual expense ratio of 0.0945% of assets, a little more than half that of Vanguard 500 Index Fund and way below most funds run by stock pickers. And tradable funds can be more tax efficient. This stems from their practice of transferring stocks -- not dollars -- to redeeming institutional holders, which allows the fund to hand off low-cost, and thus high-tax, shares. While Mr. Mench never relied heavily on conventional index mutual funds -- he previously used individual stocks to accomplish asset-allocation goals -- many in his profession have switched to tradable funds from the older variety. "I'm a little atypical in that respect," he says. Thus, financial advisers are among those causing fund firms to feel some heat from the new products. 'A Piece of the Action' To Ann Jones, the 67-year-old wife of a retired engineer in Charlotte, N.C., many of the complexities of tradable funds don't resonate. She likes the Nasdaq-100 stock mainly as a diverse technology play. Mrs. Jones learned about the Nasdaq-100 shares upon their launch, as she listened to the business-television channel CNBC. A few hours later, she called her broker to order 100 shares, using money she had recently inherited from her late mother. But before completing the purchase, she had to explain the product to the broker. "He had never heard of it," she recalls. "It's like a sampler" of technology stocks, she told him. If the small chunk of Mrs. Jones's assets hadn't gone into the tradable fund, she figures it would have gone into conventional index mutual funds or perhaps the individual technology stocks she had started dabbling in. Despite her seemingly adventurous move, she describes herself as "conservative" and "a total neophyte" when it comes to investing. So why the plunge into something so new? "It's a good way to get a piece of the action" in tech, she declares. The Nasdaq-100 tradable fund now sits in the Jones portfolio alongside some Vanguard index mutual funds and shares of chip maker Intel and fiber-optic company JDS Uniphase. Since buying the Nasdaq-100 stock, Mrs. Jones has watched the price double, then dive, then rise again. It is currently up about 80% from when she bought it, but still off the highs of this past March. "I'm really not into the in-and-out" trading, says Mrs. Jones. "I'm in it for the long term."