From the January 2008 issue of Research Magazine • Subscribe!

January 1, 2008

Swimming with PowerShares

When PowerShares Capital Management launched its first two exchange-traded funds (ETFs) back in 2003, a number of observers predicted the company wouldn't survive. At the time, PowerShares was undercapitalized and facing stiff competition from much larger rivals like Barclays Global Investors (with its iShares), State Street Global Advisors (SPDRs) and Vanguard.

At the center of the uncertainty was whether investors would want to invest in PowerShares ETFs, which broke the then-standard indexing mold by using quantitative formulas for selecting stocks and alternative weighting methods. These "intelligent" actively indexed ETFs lack the familiarity of a name like Dow Jones or Standard & Poor's behind them, but they offered the chance to outperform traditional market-cap-weighted index funds. Index funds that outperform major market indexes? How could it be? To this day, many traditional indexers still might consider such a thought as outright blasphemy.

Unfazed by all of this, Lisle, Ill.-based PowerShares continued to hum along to become what it is today: an ETF player to be reckoned with. Confirming the viability of the path that PowerShares had blazed, mutual fund giant Amvescap (now known as Invesco) acquired the company in 2006. The deal was a match made in heaven. PowerShares got the distribution and marketing muscle it needed and Amvescap got to cash in on one of the hottest investment ideas to hit the asset management business in decades.

Today, PowerShares offers more than 100 index ETFs in a broad array of asset classes, including domestic and international equities, industry sectors, currencies, commodities and fixed-income securities. At the helm is CEO Bruce Bond, who recently took the time to talk to Research about the latest developments at his company.

Research: What's been the most notable change at your company since being bought?Bond: The most notable change is that we now look forward to leveraging the global breadth and infrastructure of Invesco.

You launched the PowerShares DB Commodity Index Tracking Fund (DBC), the first diversified commodity-linked trust, in February 2006. As an asset class, are commodities beginning to get more respect from investors and financial advisors?We feel that commodities are definitely beginning to get quite a bit more respect from investors and financial advisors. They are increasingly being viewed as something that should be a portion of everyone's portfolio. In addition, we feel they're a solid asset class for individual investors to participate in, and with ETFs, these investors don't have to set up separate options and futures accounts to participate in commodities.

One of the original ideas of index investing was to create more transparency for investors, yet we're actually seeing a lot less of it today, especially with how some of the newer index providers closely guard their methods as "proprietary." Is this a bad or good trend?We feel this is part of the evolution of indexing. For example, our methods address the intelligent/value-added side of indexing. We think the variety of methods out there is actually a good thing. Cap-weighted indexes were developed to be measurement tools, and that's what they do, but the intelligent indexes used by PowerShares are designed to be investable and to outperform the market.

Various PowerShares ETFs have adopted a distribution and service model in which the funds "may" bear a 12b-1 fee of up to 0.25 percent. Is PowerShares planning to eventually impose 12b-1 fees and if so, will it affect all shareholders, or just the ones that work with a financial advisor?We have no plans to ever have a 12b-1 fee.

Last year was the year of the bond ETF and PowerShares played a part. Tell us more.We are extremely excited about having made such an important contribution to the bond ETF market in 2007. PowerShares is the only company out there offering insured municipal bond ETFs: namely, the PowerShares Insured National Municipal Bond Portfolio (PZA), PowerShares Insured New York Municipal Bond Portfolio (PZT) and PowerShares Insured California Municipal Bond Portfolio (PWZ). Our funds are based on Merrill Lynch indexes that have consistently outperformed other municipal indexes over long time periods. We aim to empower investors with these intelligent indexes and provide them with additional value beyond the other fixed-income fund offerings available.

Is PowerShares actively pursuing the 401(k) retirement marketplace?We are assessing opportunities in this market and we find these opportunities to be very interesting, but we have not made any immediate plans.

What's more important to the future growth of the ETF industry: being a serious player in the $2.5 trillion 401(k) marketplace or having actively managed ETFs?We think both are very important. We are looking at each, and we feel each has significant opportunities attached to it. What we feel is of most immediate importance, however, is providing education to the market so people can understand how to use the ETFs available to them today for investing and building their portfolios. As much as we look forward to these areas of growth, we must also look to support the products we have out there today and be a source of education and guidance to advisers looking to incorporate ETFs into their clients' portfolios.

Name one thing you like about the ETF industry and name one thing you don't like.The one notable challenge we encounter is the erroneous notion that all indexes are created equal -- and that all ETFs are based on benchmark indexes. We like many things about the ETF industry. What we find most stimulating is the opportunity to usher in a new era of investment tools for investors. We think this is an extraordinary proposition for us. We believe there is a new future ahead in terms of how people invest their money, and we are at the forefront of this. PowerShares is a key architect of the new future of investing, and we look forward to exciting times ahead.

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Ron DeLegge is the San Diego-based editor of www.etfguide.com.

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