Dolan Sees More Use Of Sector ETFs In Place Of Stocks

Dan Dolan is director of wealth management strategies for Select Sector SPDRs. Previously, he spent 18 years at Merrill Lynch in a variety of research and management roles. In 2003, Dolan left Merrill to join Alps Distributors to focus on the Select Sector SPDRs operations.

On Wednesday, he discussed recent market changes and the future of sector exchange-traded funds with IndexUniverse.com Managing Editor Murray Coleman.

IU: You started 2008 with $25.9 billion in assets and finished the year with $23.2 billion. Was that a disappointment?

Dolan: We were up 521.6 million shares in 2008. That represented a 77% increase in shares outstanding. In terms of trading volume, our average for all nine Select Sector SPDRs was 260 million shares a day. That was up from 90 million in 2007 and 45 million in 2006.

IU: Most of last year's decrease in assets was related to market depreciation?

Dolan: Yes. We had a great year up until the fourth quarter. The trading volume, shares outstanding and interest in Select Sector SPDRs was all great. But our ETFs are made up of the S&P 500 stocks. And XLF is the biggest of the group, even though Financials were down 55% for the year.

Dolan: The institutional use of the products continues to evolve. Whereas most ETFs are used as mutual fund substitutes, a lot of the sector-based products are being used as stock substitutes. Many institutional investors are opting for taking a basket of stocks rather than taking the risks of using individual stocks.

Dolan: I'll take any improvement in the market and see. The more we see unexpected announcements by companies about hits in off-balance-sheet activities, this lack of corporate trust is going to be with us.

Dolan: Clearly when you have the volume of 260 million a day, some are using it as a trading vehicle. But others clearly aren't. They're trying to take advantage of some investment theme. And the short side of the market is pretty active right now as well. Trying to decide which stock to short is difficult. We have about 230 million shares outstanding on the short side right now. And we're seeing more and more of it.

IU: Should Select Sector SPDRs be considered a part of State Street Global Advisors' ETF lineup?

Dolan: Sector SPDRs are advised by SSgA. It really started with a partnership in 1998 between Merrill Lynch, State Street and the Amex. The idea came out of Merrill, where I worked. The indexes are controlled by Merrill Lynch. The assets are managed by State Street and the sales responsibility is Alps.

IU: State Street has, for example, a Telecom ETF. So from an investor's standpoint, what's the difference?

Dolan: The Sector SPDRs Trust consists of nine ETFs which divide the S&P 500 into pieces. There are no stocks in the Sector SPDRs that are outside the S&P 500. Since that time, others have introduced finer slices of the market where industries are rolled up into sectors. We only have nine sector SPDRs because the 10^th S&P sector only has nine stocks. You can't make an ETF with that small of a number. So we decided to roll those nine stocks into Technology because they have a very high correlation to each other.

IU: You've just cut expense ratios on all nine Sector SPDRs, haven't you?

Dolan: Those changes became effective on Jan. 31. When we launched them in 1998, their expense ratios were each at 65 basis points. As assets have grown, we've continued to lower expenses for everyone. Even though last year was brutal, we were able to shave fees on various administrative and marketing costs to drive expenses lower. Going from 23 to 21 basis points might not seem like much, but it represents an 8.6% reduction. On the other side, Vanguard moved its expense ratios in the sector space higher, from 22 to 25 basis points.

Dolan: We've stuck to our main focus. And it has served us well. In December 1998, there weren't even 20 ETFs on the market. In fact, Northern Trust just announced they were going to close their 17 NETS. In the mid-1990s, Deutsche Bank launched a whole series of country-specific ETFs. And they closed within a year, if I remember correctly. So to launch nine in the late ‘90s was a significant event back then in the ETF world. And our assets have steadily grown. We had about $4 billion in assets to start 2003. Our high watermark was four months ago, when we had over $35 billion. So it has been a great ride.

Dolan: We were the first mover in sector ETFs. Then iShares came out with their series of sector products. Vanguard followed and now PowerShares has two sector ETFs. In the last couple of years, ProShares and Rydex have come out with leveraged sector products. According to a recent Morgan Stanley report, there are 152 pure sector and industry ETFs on the market now. And that's not even including the leveraged and inverse products. But we were the first and still the largest by far.