Family Portrait: PowerShares Capital Management LLC

PowerShares Capital Management LLC is young, relatively small, and about to experience a growth spurt.

The company, which debuted as a marketer of exchange-traded funds about two years ago, is set to introduce eight more ‘intelligent’ ETFs this week, expanding its roster to nineteen in all.

The latest offerings track sectors such as biotechnology, pharmaceuticals, semiconductors, and software using a proprietary methodology that seeks to deliver higher returns from indexes based on those industries while lowering volatility.

Exchange-traded funds track indexes of stocks. Unlike open-end index mutual funds, their shares can be bought and sold throughout the day, as well as typically sold short. ETFs also feature low turnover, which helps to maximize tax efficiency, and low expenses.

PowerShares, however, has pushed the envelope by offering ETFs that attempt to beat market indexes instead of just track them. In what could be seen as a move towards eventual actively managed ETFs, the firm’s offerings attempt to replicate what it calls “Intellidex” indexes, which are designed to beat the benchmarks of traditional indexed ETFs through stock selection.

Companies are included or excluded from the indexes based on 25 factors. These included cash flow, a stock’s historical trading range, analysts’ consensus estimates, and earnings growth, said Bruce Bond, the company’s president and chief executive officer. The indexes were developed by the American Stock Exchange, where the funds trade, with assistance from PowerShares.

The indexes’ component companies change quarterly. As a result, the funds’ portfolios can have “a good amount of turnover,” ranging from 50%-150% annually, according to Bond. That’s higher than the average indexed ETF. The company notes, however, that its ETFs are structured to keep capital gains taxes to a minimum, or avoid them altogether.

Through late May, PowerShares’ two oldest funds, PowerShares Dynamic Market Portfolio (PWC) and PowerShares Dynamic OTC Portfolio (PWO), had both generated annualized average returns of more than 21% since their inception two years ago. For the one-year period ended May 31, 2005, both have beaten their respective benchmarks by a wide margin: Dynamic Market Portfolio rose 16.1%, versus 7.4% for the S&P 500. Dynamic OTC Portfolio rose 20.6%, versus an advance of 4.1% for the Nasdaq composite. More meaningful performance comparisons are not available due to the short track records.

Bond, a former vice president and managing director of Nuveen Investments who founded PowerShares, said assets under management have grown to about $1 billion. Some 80% of that is from individual investors, with the rest coming from institutions. To be sure, competition in the ETF space is not letting up with behemoth Barclays Global Investors and its iShares family of ETFs, holding over $100 billion in assets, and State Street Global Advisors, another sizeable early entrant. Fidelity Investments, Vanguard, and others, have joined the fray.