But something happened after 2004 that caused seed capital to dry up. A variety of explanations have been offered: smaller spreads, new regulations, fewer blockbuster products, etc. For whatever reason, specialists became very reluctant to seed new ETFs. This has gotten worse recently, as the credit crisis has put an extra premium on cash.

Investors are feeling the fallout in a number of ways. For one, several funds have failed to launch this year, simply because they couldn't find seed capital; other launches have been delayed. And even those funds that have launched have done so with the absolute bare minimum of assets—typically just $2.5 million or so. Data show that funds with fewer assets tend to have wider spreads, and the spreads on these new ETFs have been significant.

It's a nasty feedback cycle. The lack of seed capital stifles innovation among ETF issuers, so fewer new funds come to market. Those funds that do come to market have high spreads, which makes it hard for them to attract assets. Because new funds aren't attracting assets, specialists are reluctant to commit seed capital in the future.

It's a big problem for the ETF industry, and MacroShares thinks it may have the solution.

The MacroShares Model

MacroShares is planning to launch its new house-price ETFs using a unique "open IPO" process. Rather than having specialists provide seed capital, MacroShares will allow broker-dealers—any broker-dealer who registers with MacroShares—to sell shares directly to investors prior to the launch. Those underwriters will be compensated in two ways:

1. Investors will be charged a per-share commission of 0.4% to 1.8% depending on the number of shares sold, which will be paid to the broker-dealer.

2. Broker-dealers will receive a pro-rata portion of the total expenses paid to the fund forever.

It remains to be seen if the MacroShares program will work. The IPO was originally supposed to run from Nov. 3–Nov. 17. That was postponed "due to market conditions," and some wondered if there simply wasn't enough demand. MacroShares’ Chief Executive Sam Masucci shrugged that off, telling ETFR that it saw demand for $250 million–$500 million.

The latest indication, according to a recent IU.com interview with the company, is that the auction’s excepted to come sometime in April. But Masucci cautioned that such a rough estimate was tied to the SEC’s giving the funds a green light. (See related story here.)

But at a time when many ETFs are struggling to find any seed capital at all, the MacroShares approach at least offers an interesting alternative.  

1 | 2 |