Index Universe (IU): Why did Barclays Capital create its family of ETNs?

Philippe El-Asmar (El-Asmar): We created the iPath family to complement the existing iShares ETFs that Barclays Global Investors were offering. They are meant to give access to more difficult-to-reach asset classes.

IU: How does a decision get made as to whether an index will be used to underlie an ETF or an ETN?

El-Asmar: It's a very close collaboration and partnership that we have between BGI and Barclays Capital, and we regularly meet to discuss the plans for the next three-to-six months, or the next year or possibly even longer-term plans. The first priority is to basically give investors choices and respond to the needs of clients. The primary driver for us in launching a product is not our agenda, but more the response to feedback we've collected from clients over time.

We're pretty agnostic with regard to the choice between one instrument and the other. Often there is value in each of the instruments depending on what the investor really wants, and in the past, we have offered an ETN and an ETF tracking the same underlying index. Generally speaking, we collaboratively try to fill the gaps using ETNs as a means to access more difficult-to-reach markets and ETFs as the traditional vehicle.

IU: Beyond the collaboration with BGI, what is driving the expansion of the iPath ETN family?

El-Asmar: The primary driver here is providing the clients with what they want and giving them choices. We didn't try to launch hundreds of ETNs and just hope that some will succeed. We've always been very cautious about providing investment products that we think will see long-term demand from investors. Commodities, for example, are in everybody's mind as an established asset class, but four years ago. very few people had exposure to commodities.

We're not saying when we launch a commodity ETN that right now is the right time to invest in commodities. What we're saying is if you decided to invest in commodities, this is the best way you can access the data class-a very simple, transparent, cost-efficient way, with the convenience of trading on an exchange.

IU: Barclays Bank was the first in the ETN space. Do you see a lot of new players coming into the field beyond the ones that are currently there now?

El-Asmar: Yes; we know of at least two other banks that are working very seriously on their exchange-traded note platforms. We've had, since we entered the market in 2006, about six or seven separate issuers create ETNs themselves as well.

IU: Are there high barriers to entry to the market? Barclays was kind of out there by itself for a while.

El-Asmar: I think it does take a lot of time and energy and effort to create the architecture around an exchanged-traded note program, and often the first is the most difficult to do. So yes, it does take time for other issuers to catch up, but relatively speaking, we were in the market uncontested for about a year, and that might have been a little bit longer than what we anticipated. Typically speaking, it would have taken maybe six months for the competition to copy us.

IU: What kind of growth do you anticipate in the ETN market?

El-Asmar: There's been tremendous growth in the last two years in the exchange-traded note space. The first one was launched in June of 2006, and today you have about 58 separate ETNs and close to $6.2 billion in assets. I think that that is going to continue and you're going to see more ETNs in terms of numbers as well as in terms of additional ETN platform providers coming to the market. So you're going to see both of these trends happening in the next few months.

IU: Do you see them following a similar trajectory as ETFs?

El-Asmar: I think if you just looked at the first two years of existence of ETFs, probably ETNs have grown faster just year-over-year. We're living in a different environment as well, so that's maybe not a good comparison in absolute terms. But, yes, the trajectory is substantially faster than the trajectory or the growth in the exchange-traded fund space. When the first $1 billion mark was met, or the $2 billion or the $5 billion was met, the ETN space was growing much faster than when the first $1 billion was met in ETFs and the second billion or fifth billion.

IU: Where do you see the industry, in about a year? What about five years out?

El-Asmar: Today it's about $5.5 billion, and that's after less than two years of existence. In three-to-five years' time a good number for the industry could be $30 billion to $50 billion. It could be much bigger than that if there continues to be a demand for new asset classes. In particular, I think the big themes are going to be around alternative investments and algorithmic strategies and possibly active exchange-traded products.

IU: Is there a typical ETN investor?

El-Asmar: We've actually looked at that, and we have a broad set of investors. It actually depends on the ETNs. In some ETNs you have asset managers like mutual funds, you also have hedge funds, you have endowments, foundations, RIAs, banks, private banks, etc. It's a good mixture.

The typical investor is more of an asset allocator or a trader, somebody looking to allocate a certain part of a portfolio in a simple, transparent and cost-efficient way with the ease of trading on the exchange or the liquidity of the exchange. The other type of ETN purchaser or seller is more of an active trader, who basically wants to hedge an overall portfolio and to do that with a very easy-to-trade instrument.

IU: Could something like the Bear Stearns fiasco have an effect on how ETNs are viewed by investors?

El-Asmar: In the case of Bear Stearns, the primary concern of investors was the creditworthiness of Bear Stearns and that the window of redemption was a one-week window, so basically people had to wait until the Thursday after what happened on Friday and Monday without having the peace of mind of being able to exit. I think that shows the importance of the credit rating of the issuer, the fact that there is a credit risk involved in ETNs and its effect and that investors should be aware that they are having a trade-off between credit risk and tracking error. That's a trade-off between ETNs and ETFs. Also, there are some ETNs that are superior to others because some ETNs offer overnight liquidity versus weekly liquidity. When we created the ETNs back in June of 2006, we were offering only weekly redemption windows, but now we offer them on a daily frequency. Many of the other ETN providers have followed suit, but many still have weekly redemption features.

IU: Why do so many ETNs track the commodities market?

El-Asmar: I think it's a trend that has been set by us since we were the first to market commodities ETNs. Since the launch of DJP [iPath Dow Jones-AIG Commodity Index Total Return ETN], different banks have tried to break into the ETN space, and they've piggybacked on this success. Now the ETN structure is almost the preferred route for investing in commodities between the two vehicles, although I would just moderate that by pointing out that the ETF GLD has close to $20 billion. My comments were more in regard to broad-based commodity indices rather than specific commodities or commodities sectors.

The reason why we came up with the ETNs linked to commodities is because we were on the investment banking side and servicing a lot of institutional clients that could access commodities. But for regular investors, there was no simple choice. The same feedback was being collected from BGI for a long period of time from the various clients that invest in ETFs; they were asking for that asset class as a good way of diversifying the portfolio allocation and benefiting from the commodities markets' performance as well as for other reasons, such as potentially hedging against inflation.

IU: Beside being first to market, what are the iPaths' main competitive edges in the ETN industry?

El-Asmar: For one, quality of the issuer: Barclays is one of the best-viewed and highest-rated financial institutions in the world. I think that does matter in terms of mitigating the credit risk. There's also the fact that we offer daily creation and redemption versus weekly. I think that provides again another competitive advantage, which mitigates some of the credit risk for investors. With that, you only have an overnight risk on an AA-rated entity. There's also the wide range of choices across asset classes like commodities, currencies and emerging markets equities as well as strategies. We're providing the most complete menu compared to any of the other providers.

IU: Is INP [iPath MSCI India Index ETN] ever going to return to fully normal operations?

El-Asmar: We are diligently working with the Indian regulators on finding a solution on this.

IU: In light of the IRS ruling on currency ETNs, is Barclays' strategy going to be changed in regard to any currency ETNs it releases in the future?

El-Asmar: We have launched an ETN linked to a currency index called the Barclays Intelligent Carry Index. Outside the ETN space, more in the structured investment space, we've done a lot of principle-protected investments linked to baskets of currencies and products along those lines. Some of the ETNs that we've created pay income; others are still just growth. We're considering a fuller suite of exchange-traded notes with an income-embedded feature.

IU: Did the ruling have an effect on the existing currency iPaths? Did it hurt them in any way or is it just something that investors accepted and that was that?

El-Asmar: The assets under management on the three currency ETNs we have are still at a similar level as what they were before the ruling; for the moment, it has remained constant.

Philippe El-Asmar is a managing director and the head of investor solutions, Americas for Barclays Capital. IndexUniverse.com assistant editor Heather Bell spoke with him recently about the iPath family of ETNs and how the overall ETN market is developing.