Interactive Q&A: Jeffrey L. Feldman, Creator of HealthShares and Founder and Chairman of XShares Group LLC

This is the latest in the Seeking Alpha series of interviews with leading ETF firms of interest to our readers. These, however, are interviews with a twist: the executive has agreed to answer questions and respond to comments not from a single interviewer, but rather from our community of readers and contributors.

This interactive Q&A is with Jeffrey Feldman, Founder and Chairman of XShares Group LLC, a leader in a new approach to bringing innovative Exchange Traded Funds (ETFs) to market on its administrative platform. XShares Group has sponsored this interview, which works like this:

• Jeff briefly introduces himself and the issues he's focused on below.
• Readers and contributors can immediately start to post questions and remarks using the comment box below (Note: you need to sign up for free registration and be logged in to do so).
• Seeking Alpha editors will not filter or edit the questions and comments from readers, except to delete insulting or overly aggressive language.
• Jeff has agreed to respond to the questions and remarks by beginning to post answers to readers' questions on Thursday, April 12th. Readers can track his answers and respond to them during that period, with the resulting dialogue remaining on the site.
• Readers can respond to his responses during that time.

Yahoo Finance readers may join the Q&A by following this link.

Over to Jeff:

Hello, I am Jeff Feldman, Founder and Chairman of XShares Group LLC (XShares).

Thanks to Seeking Alpha for providing this opportunity to chat directly with the ETF investment community. XShares Advisors LLC (XShares), a subsidiary of XShares Group LLC, is a registered investment advisor that provides investment advisory services to Exchange Traded Funds. XShares also partners with major institutions and index providers seeking to bring innovative Exchange Traded Funds to the market using its administrative platform.

Our initial product launch was the HealthShares™ family of ETFs earlier this year. HealthShares™ divide the healthcare industry into unique Verticals that include companies with diversified market capitalizations. Companies included in the HealthShares™ ETFs typically range in size from $100 million to $15 billion in market capitalization. Each HealthShares™ ETF creates a meaningful position in companies within a specific therapeutic or geographic area that are developing next-generation products.

Additionally, XShares is exploring new products based on carbon emission credits and targeted geographic portfolios based on states.

I'm happy to discuss a range of topics with Seeking Alpha's readers, including:

• the HealthShares Exchange traded Funds
• the approach to building narrow portfolios through ETFs
• correlated versus non-correlated assets in building portfolios
• how to build a portfolio with ETFs
• the projected growth in ETFs.

-------------------------------Important Disclosures----------------------------------
This forum is an interactive dialogue between Mr. Feldman and users of the site. The opinions expressed by Mr. Feldman herein are his own and do not represent the opinions of XShares Advisors LLC, HealthShares Exchange-Traded Funds or any other person or entity. Nothing herein should be construed as a forecast of future events, a guarantee of future results or investment advice. Nothing herein may be deemed an offer or sale of any investment product and it should not be relied on as such. The user of this information assumes the entire risk of any use made of the information provided herein and neither Mr. Feldman, XShares, HealthShares or any other person or entity makes any representation as to the accuracy of any statements expressed herein or any express or implied warranty. This information is not to be reproduced or redistributed.

Before investing in HealthShares Exchange-Traded Funds, an Investor should consider the fund’s investment objective, risks, charges and expenses carefully.
For this and more complete information about the fund call 800.925.2870 or visit the website www.healthsharesinc.com for a prospectus. Please read the prospectus carefully before investing.

There are risks involved with investing in ETFs, including HealthShares, including possible loss of money. HealthShares™ are not actively managed and are subject to risks similar to stocks, including those related to short selling and margin maintenance. HealthShares™ ETFs are subject to increased risks associated with investing in a specific sector compared to more a diversified investment.
The prospectus is not an offer to buy or sell the portfolio shares, nor is the fund soliciting an offer to buy its shares, in any jurisdiction where the offer or sale is not permitted.
The HealthShares ETFs are registered for sale in the United States only and are not intended for use by non-US investors.

HealthShares ETFs are distributed by ALPS Distributors, Inc.

Comments

[RogerNusbaum]

Thank you for the time with this.

Main stream media seems to favor picking on the narrowness of your product line in a way that borders on the peculiar. Is this simply a "fear of the unknown?" If so how do you reply?

The more important thing to me would be do you view the various HealthShares funds as suited for longer term or did you envision a shorter term, trading mind set for individual investors or institutional investors to have success?

Thank you,
Roger Nusbaum

[Jeff Feldman]

The “narrowness” of our product line relates to the fact that we have 22 to 25 stocks in each portfolio. Since we currently have 15 ETFs trading, one could obviously build a broad healthcare portfolio using several or all of the ETFs. This would create exposure to hundreds of stocks. The fact is that modern portfolio theory has proven that the risk diversification from a 22 stock portfolio is the same as that from a 200 stock portfolio.

Our ETFs are designed to own companies that have products on the market or in late stage clinical trials. The ETFs are organized by therapeutic area (cancer, metabolic disease, cardiology, infectious disease, etc.) to allow groupings that give investors exposure to innovation with mitigation of single-stock risk. The biotechnology industry is on the threshold of revolutionary innovation. However, it is very difficult to select the companies that will ultimately be successful. There probably are some folks who are capable of choosing the “winners” but for most this is too daunting a task. So a portfolio approach is the logical answer.

Consider our Emerging Cancer ETF (HHJ). Last week, one of the constituent companies, Dendreon (DNDN), received preliminary FDA Advisory Board approval for its prostate cancer drug Provenge. The stock was about $5 on Thursday and closed this past Monday at $23. On Monday, another constituent, Ariad Pharmaceuticals, announced that its Phase III trial for a drug to treat metastatic sarcoma is being delayed. The stock declined by 15%. Other related companies in the portfolio have experienced sympathetic volatility, both positive and negative. In total, the Emerging Cancer ETF was up 17% for the year at the close of business on Monday. I don’t know if we are dealing with fear or simply the fact that this is a new way of investing with which the market needs to get comfortable.

HealthShares are designed for long term investment but are quite suitable for short term trading. Dendreon had its FDA announcement last Wednesday and several owners of the stock were short the ETF going into the announcement (under the theory that bad news for DNDN would negatively impact the entire portfolio). But the primary purpose is for long term holders.

Healthcare currently represents 16% of the U.S. economy and is expected to grow to 20% in just the next 8 years. The “baby boom” generation is now 42 to 60 years of age and numbers 78 million people. Primarily they are healthy and have not needed to rely on the healthcare industry. But that is about to a change in a big way as this group ages. This is happening at a time when healthcare is already in dire straits with 45 million people with no health insurance, costs growing at more than 8% per year and Medicaid and Medicare facing multi-trillion dollar deficits. At the same time, technology is advancing rapidly as we evolve from the classical pharmacology model to customized medicine (pharmacogenomics).

But most of the mutual funds and ETFs that own pharmaceuticals and biotech are market cap weighted and therefore heavily skewed toward Big Pharma (Pfizer, Merck, Schering, Wyeth, etc.). So most of the opportunity is in biotech and most investment is going to the pharmaceutical companies. HealthShares affords investors the opportunity to align their investment dollars with the technologies that will be treating them in the future.

[DavidJackson]

Does this mean the HealthShares ETFs are not market cap weighted? And couldn't you achieve the result you're looking for with a sector ETF covering all of pharma and biotech, but equal weighted?

[Jeff Feldman]

They are equal weighted. In a $2 trillion dollar industry, progress will occur at different rates in different therapeutic areas and this will occur with different risk profiles. Hence it makes sense to engage in asset allocation and perhaps trade one against the other.

[SeekingAlphaEditors]

I'm curious about liquidity issues. There are only a handful of ETFs that have real liquidity for institutional investors. Are Healthshares structured in such a way that they can scale for the professional investment community out there?

[Jeff Feldman]

Exchange Traded Fund liquidity is one of the most misunderstood concepts. Generally equity securities traded on exchanges are measured by Average Daily Trading Volume for liquidity and so by extension most investors and investment professionals measure ETF liquidity by volume. Because ETFs are open –ended and can be created daily, the true test for volume in ETFs is the liquidity of the underlying basket of stocks (constituent companies) held by the fund. Generally ETFs that hold large cap stocks will have a slightly higher liquidity than funds holding mid cap securities but this is based more upon investor preferences than any real liquidity issues.

We took this concept into consideration when we developed HealthShares and based upon our analysis we do not perceive liquidity issues in these funds and the underlying stocks unless and until there is well in excess of $1 billion in assets in each fund.

The creation and redemption process takes place generally by aggregating the constituent stocks, with an appropriate program trading desk or through their internal securities lending process, and assembling the baskets that can be deposited with the ETF custodian in order to create new ETF shares. The institutional investor can obtain the position it desires and the fund can accumulate significant assets even with low ADTV of the ETF shares themselves. This is the mechanism through which many institutional investors initially enter an ETF market and may involve the establishment of an Authorized Participant Agreement with the fund distributor. ALPS distributors, Inc. are the distribution agent for the HealthShares ETFs.

Finally many of the large Authorized Participants have ETF trading desks that will assemble the baskets and create high quality block executions for institutional investors without regard to the underlying Exchange Traded Fund’s ADTV. This opportunity exists for both creation and redemption of ETFs.

[JamieRackover]

"XShares also partners with major institutions and index providers seeking to bring innovative Exchange Traded Funds to the market using its administrative platform."

Xshares sounds like it's dead-set on becoming a turn-key ETF provider -- can you elaborate a bit more on what your plans are with this "administrative platform"?

[Jeff Feldman]

A major part of our business is providing private labeled ETFs for other large recognizable financial institutions. In fact, the thought behind our name “XShares” is to allow our partners to substitute the “X” with their brand.

We’re one of a handful of companies in the world that has exemptive relief from the 1940 SEC Act to manufacture and distribute ETFs.

The comprehensive development process includes testing the index, lining up authorized participants, index calculation agents, custodians, administrators, market makers, filing of the prospectus and finding the appropriate national exchange for listing. We take our partner’s products step by step through the compliance requirements and assist in the development of marketing materials, websites, tear sheets, brochures and other collateral material and events to support the launch of the product.

Our value proposition to our partners is simple: to provide them with the platform to get their ETFs to market as soon as possible in an effort to capture as much market share as possible in this rapidly growing space.

[DavidJackson]

Many thanks for doing this Q&A, Jeff.

The carbon emission credits ETF sounds interesting. Can you provide more information about it: what kind of structure will it have, when do you expect it to launch, and who do you think it will be used by and for what purposes?

[Jeff Feldman]

Unfortunately, our prospectus is not yet filed and I am advised by counsel that I cannot comment on our carbon credit ETF. We expect the filing to take place this summer.

[DavidJackson]

Thanks Jeff. Guess we'll just have to wait...

[KobyMenachemi]

"Vertical Investing": This sounds like a fancy way to leverage ETFs by rotating into hot sectors. Is this really different from what's already out there? And why would someone who prides himself on being a stock picker want to use an ETF to capture a theme -- in healthcare, isn't it frequently "one winner take all"?

[Jeff Feldman]

A “stock picker” would not buy an ETF. In fact, a great stock picker need only select the best performing stock. Most of us are not stock pickers and biotechnology is far too difficult for most individuals to understand. Your comment about there ultimately being one winner is applicable to broad spectrum pharmaceuticals but far less true in an age of customized medicine.

Consider Dendreon, which got an FDA advisory panel last week for Provenge, a vaccine for prostate cancer. This drug (which costs $42,000 for an entire regimen) will benefit only 50,000 of the 3 million patients with prostate cancer. Yet this is potentially a $2 billion drug and with the aging baby boomers, there will be, unfortunately, many more patients in years to come. Other treatments will benefit other segments of the market. We believe there will be dozens of examples of these targeted customized medicines and there are many companies in our portfolios that are developing just such products.

So, there will be many new products which will improve therapy for all diseases in the coming years (there better be because we cannot afford to treat all patients with current products) and unless you are a brilliant investor/biologist/phy... the best way to access these opportunities in my opinion is to divide the industry into vertical segments. Now, one may develop knowledge that allows one to favor one sector over another. There may be setbacks in the development of cancer drugs at the same time there are breakthroughs in cardiology. One can then trade these portfolios against each other.

You must remember that the entire GDP of the U.S. was $2 trillion in 1977 when mutual funds first became popular. And healthcare is growing at more than 8% per year, a rate the economy has not come close to in the past 30 years. We know, looking back, that the correct way to invest in the economy over the past 30 years was using an asset allocation model to be able to rotate between sectors. The same theory applies to healthcare today.

[Panskeptic]

Hi,

As there is already at least one investment newsletter devoted to diabetes-related stocks, I was surprised not to find this special area among your healthcare offerings. Is there some reason you have avoided this supposed growth industry?

[Jeff Feldman]

Diabetes affects 21 million people in the U.S. and that number is expected to double over the next 15 years. It is a potentially devestating issue. Our Metabolic-Endocrine Disorders ETF (HHM) includes several companies that are working on new treatments for diabetes and obesity.

[Richard Kang]

Like David, I am also very interested in knowing more about your expansion to the carbon credit market. How will your ETF offering differ from direct exposure to this market? From what I know, the carbon trading market started out in the UK. Are you building your offering based on an existing template out of the UK ... in other words, is there plans for another ETF-like offering in the UK or elsewhere that you are using as a blueprint? When I first heard news of plans for this product, I assumed it was to be a US domiciled product and would be "first to market" globally (and thus, you're truly building this from scratch, not from an existing template). So, again, like David I'm interested in the structure and any unique tweaks found in what I think will be a most interesting offering.

With regard to ETFs that provide exposure to specific states in the union ... I wonder who the market for this type of investment is. From an asset allocation and portfolio construction perspective, it doesn't seem like a family of ETFs that easily fits within most investors' existing framework. My first guess would be going after various types of institutional investors (more of the smaller ones, I think). I suppose if you go to a number of California (as an example) pensions, endowments, government related organization, etc. they might have some sort of guideline that promotes local investment and then they might go for a California ETF. But in today's environment, institutions are looking globally for diversification so I don't know how much interest they would have for this ... and this is especially true for the bigger pensions like CalPERS or CalSTRS. Just curious on how you plan on marketing these.

Thanks for your time on this.

[Jeff Feldman]

I cannot comment about carbon credits at this time.

As to State Shares, I believe many investors will be interested in these securities.

I have a hard time understanding why investors want to put significant assets into emerging markets. Peter Lynch has always said, "invest in what you know." Investing in emerging markets is investing in what you know....nothing about. But investors are seeking to isolate asset classes.

Personally, I'd rather isolate California and invest there as opposed to Turkey or Malaysia. Maybe that's just me.

Your conjecture about state governments is correct.

[cdelfeld]

I wonder if Mr. Feldman would comment on how average investors can decide which one of the healthshares ETFs is right for them? Are these products primarily for institutional investors and only the most specialized individual investors?

Carl Delfeld
Chartwell ETF Advisor

[Jeff Feldman]

There are over 120 million people in this country with chronic disease. Most of us are close to at least one such person. It may surprise you but many of these people are quite knowledgeable about the disease that matters to them. They are familiar with the products in development and many of these people have an interest in (and have tried) investing in companies working on treatments for that particular disease.

In addition, someone who has a chronic illness might use these ETFs as a hedging strategy. A 30 year old diabetic, who expects to be treated for the next 50 years, may want to own a basket of companies working on metabolic disease (HHM), the very companies that a patient is likely to be paying for treatment. We have already seen purchasers of Long Term Care Insurance buy our Patient Care Services ETF (HHB) which owns companies that own and operate assisted living, nursing home and hospice facilities.

[DavidJackson]

Jeff, thanks for answering questions.

Would you talk about the expense ratios of your ETFs versus others, and also the tax efficiency, trading costs and buy-sell spreads?

Cheers,
DJ

[Jeff Feldman]

The expense ratio for HealthShares Therapeutic ETFs is 75 basis points. Our European Drugs ETF has a 95 basis point expense cap. Although 75 bps is higher than many other ETFs, it is roughly equivalent to the expense load of other specialized products.

WTFs, like other index funds in general, generate fewer capital gains due to low turnover of the securities in the portfolio. Generally, ETFs only sell securities to reflect changes in their benchmark index.

Investors in mutual funds may incur significant tax expense when the fund sees redemptions from shareholders. Because ETFs are exchange-traded, selling shareholders sell to other investors in the secondary market. In addition, since ETFs have a creation/redemption facility that allows actual securities, rather than cash, to be distributed to Authorized Participants, there is no realization of capital gain to be distributed to shareholders. Of course, liquidating an ETF position will generate capital gains or losses for the shareholder.

[MichaelKrause]

Hi Jeff,

You mention above that few people are capable of picking winning stocks in biotech, with which I agree. But I wonder about the ability of investors to pick winning theraputical areas, around which the HealthShares are organized.

If that's the case, then wouldn't it make sense to simply invest in a broad Biotech ETF (i.e., a fund that is not skewed to "Big Pharma")? Or do you think some some theraputical areas look more promising than others?

Best regards,
Michael Krause
etfresearchcenter.com

[Jeff Feldman]

If the economy is to survive, we need to have winners in all therapeutic areas. And one can look at the products in development and know that is possible. A "broad biotech ETF" does not provide meaningful exposure to many of these companies. In addition, individuals care more about one therapeutic area than another and some may know more about one area than another.

Different therapeutic areas will look "more promising" at different times. That is why it is important to have well-defined portfolios.

[DavidJackson]

Hi Jeff,

Can I take you up on your offer to discuss "how to build a portfolio with ETFs"?

-- Do you think non-professional investors should have portfolios that are filled entirely with ETFs?

-- Can you describe an ETF portfolio that you personally would be happy to use, understanding that this isn't a recommendation for others?

Thanks!

[Jeff Feldman]

Different strokes for different folks. There is a broad spectrum of investor desire from very aggressive to risk free. The great news about ETFs is that we can create portfolios for any objective.

However, most ETFs are broad risk mitigated indexes. We are not addressing ourselves to investors who are capital appreciation oriented. There have been a number of articles in the press lately about how wealth polarity has reached an all-time high in the U.S. One percent of the epopulation has 20% of the wealth. And those people did not achieve their wealth by buying risk-mitigated broad diversified indexes. That's what the other 99% are buying.

Individuals should have the opportunity to participate in the private equity and venture capital and arbitrage strategies available to the wealthy.. Those who are satisified with their net worth should buy the broad indexes and preserve their wealth. But we DIVERSIFY to stay rich; we CONCENTRATE to get rich. The beauty of narrowly focused ETFs is they represent diversified concentration.

I do not believe any portfolio should be "entirely" filled with anything. My key words would be focus and flexibility.

Personally, I believe the greatest opportunity for wealth creation in the U.S. is in healthcare. I want to be substantially overweighted in HealthShares and will avail myself of funds that are replicating capital appreciation strategies, whether from XShares or any other provider.

[DavidJackson]

Jeff,

Most of the cash flowing into ETFs is going to Barclays and StateStreet ETFs. How can your ETFs compete with their marketing muscle? Are you expecting most purchasers of HealthShares and your new ETFs to be retail investors looking to play hot themes?

Appreciate your participation.

[Jeff Feldman]

We are and intend to offer products that are not available anywhere else. Estimates abound that more than $2 trillion will flow into ETFs in the next 4 years. If that were not the case, we would not be able to compete. But this industry is still in development and there will be several more important palyers beyond the current group.

ETFs are a disruptive technology and the industry being disrupted is the $10 trillion mutual fund industry. There is more than enough for everyone.

[DavidJackson]

Hello Jeff,

Which do you think are the most interesting ETFs on the market and in registration, other than your own?

Thanks!
Darren

[Jeff Feldman]

I like the ETFs that offer investors access to strategies that are not otherwise available to them. The ProFunds series is unique and useful and I like PowerShares Water and Cleantech ETFs.

[DavidJackson]

FYI for readers:

ProFunds provides inverse ETFs (ETFs that provide the opposite performance to an index, so if the index rises the ETF falls -- a short bet), leveraged ETFs (ETFs that provide twice the performance of an index, so if the index rises by 1% the ETF rises by 2%), and short leveraged ETFs (if the index rises by 1%, the ETF falls by 2% -- a strong short bet). The ProFunds family includes inverse and leveraged ETFs covering the main indexes, growth and value, and individual sectors.

You can find articles on the ProFunds ETFs here.

[User 39448]

Hi Jeff,
Thanks for doing this. It's very informative.

Quick question for you: Xshares definitely is innovating and helping the development of lots of new product and is leading the way towards this multi-trillion dollar asset flow away from mutual funds towards ETFs. I assume we'll see, as we saw in the mutual fund peak, thousands of ETFs eventually.

With so many new ETFs out there, what kind of tools/data/content are investors using or need to be developed to fully size-up which ETFs are right for which portfolios? Where are the opportunities?

[Jeff Feldman]

The industry needs a Bloomberg for ETFs. We need data and analytics for investors.

You are correct, this is truly a gating issue that must be addressed.

[Aaron Singer]

Thanks for participating in this, Jeff.

It's very interesting to hear about Healthshares and Xshares behind it. You mention above that you're open to discussing ETFs with correlated vs. non-correlated assets.


I assume the stocks in individual Healthshares are highly correlated. How are ETFs with highly correlated assets to be used in constructing diversified portfolios? Aren't most investors using ETFs to create highly diversified portfolios?

[Jeff Feldman]

We agree that adding low-correlated assets to a portfolio can add the benefits of diversification and make a portfolio more efficient. The HealthShares Indexes are not highly correlated to the Large-Cap HealthCare Sector and in most cases they are not highly correlated to each other.

From 2001 through 2006, based on our back-tested results, the HealthShares Indexes had correlations between 0.46 to 0.61 with the S&P 500 HealthCare Sector (not including the HealthShares Composite Index which came in at 0.7).

For a complete analysis of the correlation of the HealthShares Indexes contact us at 800.925.2870.

[DavidJackson]

Jeff, two quick follow-ups if I may on the overall ETF industry.

-- What do you think the impact on the mutual fund industry will be of ETFs?

-- How profitable do you think the ETF industry will be?

Many thanks,
David Jackson

[Jeff Feldman]

ETFs are here to stay and will be a significant asset class. Mutual funds and ETFs will co-exist. There will be ETFs of mutual funds and mutual funds of ETFs. Some mutual fund sponsors will find they can best grow their assets under management by creating ETFs.

To some extent, growth of ETFs will be a function of what happens in the stock market. I believe the biggest impediment to asset growth would be a roaring bull market. In such a scenario, greed routs fear and individuals are emboldened to buy the individual stocks that are rising the fastest. In a prolonged bear or sideways market, fear wins out and investors will seek to minimize costs which favors ETFs.

The ETF industry can be as profitable as the mutual fund business. Technology will continue to evolve and we will likely see costs decline faster than expense loads over the next several years. Of course, the wild card is what happens in the mutual fund industry. If mutual funds can become competitive with ETFs on fees and expenses, then the margins for ETFs will be squeezed.

[tlydon]

Jeff-

I caught a portion of your presentation at the World Series of ETFs in Miami a few weeks ago. Nice Job. It's apparent you're either educated in the medical area or have some experience in the health care arena. Would you mind sharing a little more about your background? It's refreshing to see a CEO with the in-depth knowledge and enthusiasm in the products offered.

Not a bad week for performance and fund flow for HealthShares funds either.

Thank you,

Tom Lydon
ETFtrends.com

[Jeff Feldman]

Thanks, Tom. No, I have no formal training in either medicine or healthcare. I do have close to 40 years on Wall Street and I have taught macroeconomics for nearly that long. I started my career as an analyst at Goldman, Sachs and then started my own firm in the 70's. I have spent my life studying the nexus of the capital markets and the macro-economy and have devoted my business career to developing capital market tools when I think they are needed. I became sensitized to the current healthcare crisis in the US about 8 years ago and recognized that we needed to find a way to invest in the innovations that might alleviate the crisis. Thus began a journey that led me to create HealthShares. It may appear that we have burst on the scene, but this has been a long slog. The press may have have its fun calling me stupid, but I can assure all that a great deal of effort and thought went into the creation of this product.

[SeekingAlphaEditors]

Having hit the time limit on this interactive Q&A, we're now closing it to further questions.

Many thanks to Mr Feldman for his participation, and to Seeking Alpha's readers for their questions and comments.