Acquisition important in industry with few players

AMVESCAP PLC, London, is expected to take over distribution of 37 exchange-traded funds run by PowerShares Capital Management LLC, Wheaton, Ill., as early as July, once the acquisition of the ETF operator closes.

The purchase — the first time a money manager acquired an American ETF operator — could be a springboard for more deals.

"It's going to turn out to be a really important transaction" as part of merger and acquisition activity in the money management industry, said Donald Putnam, managing partner of advisory merchant bank Grail Partners LLC in San Francisco.

In an industry with only a few players, "there will be one or two more transactions in the next couple years," Mr. Putnam said. He declined to comment on firms that could be in the market to buy or be sold.

Denise Valentine, senior analyst at Celent LLC, a research and consulting firm in Boston, said the expected introduction of actively managed ETFs also could spur M&A interest by some mutual fund companies.

Aside from M&A activity, the potential for more change in the ETF industry is being driven by a bumper crop of new and differentiated strategies from by all kinds of providers. Within the last several weeks, State Street Global Advisors, Boston, launched six more to now manage a total of 65; WisdomTree Investments, New York has introduced its first family of 20 fundamentally weighted dividend index ETFs; and ProShare Advisors Inc., part of ProFund Advisors LLC, Bethesda, Md., rolled out eight new ETFs with "short or magnified" exposure to an index.

And PowerShares recently filed with the Securities and Exchange Commission to launch 31, 10 of which will be based on money manager Research Affiliates' fundamental indexes, sponsored by the FTSE Group, London.

Analysts at Morgan Stanley & Co. International Ltd., London, have speculated in a research note that PowerShares could be the growth engine at AMVESCAP the way Enhanced Investment Technologies LLC — the Palm Beach Gardens, Fla., firm known as INTECH — is at Janus Capital Group, Denver. INTECH, whose assets under management have grown to $50.6 billion as of March 31, up from $15.5 billion for the same period on 2003, has helped Janus improve performance and curb outflows.

The PowerShares deal signals an important step by executives at AMVESCAP and its AIM Investments unit to revive business following outflows over the past several years (Pensions & Investments, May 1).

The deal includes incentives for PowerShares' executives such as President and Chief Executive Officer Bruce Bond and Managing Director John Southard based on future asset-management fee growth over several years, according to a proxy statement.

PowerShares had more than $6 billion in assets under management as of May 31, up from $1 billion in June 2005. It introduced its first two ETF strategies in May 2003. Its ETFs are based on "intellidex indexes" licensed from the American Stock Exchange and rely on rules-based quantitative screens to choose holdings.

AMVESCAP brings to the union a 450-member sales and marketing force through subsidiary AIM Distributors Inc. AIM Distributors markets mutual funds represented by AIM Investments, both in Houston. AIM Investments has "not delved extensively into the RIA space," said Gene Needles, president and chief executive officer of AIM Distributors. "Now we have a door opener."

AIM Investments is exploring placing PowerShares' ETFs into a collective trust and packaging them in defined contribution platforms for clients, said Ivy McLemore, spokesman. AIM Investments also is considering a fund of funds based on ETFs, Mr. Needles said.

In the meantime, AIM Distributors will promote the ETFs alongside AIM Investments' actively managed mutual funds, separate accounts and variable annuity strategies as part of a "core-satellite approach," Mr. McLemore said. AIM Investments had $80 billion in actively managed strategies as of May 31.

PowerShares' 10 external sales professionals will act as specialists to market the ETFs, Mr. Needles said. That sales effort will be led by Robert Brooks, former national sales manager at SSgA, who joined PowerShares in early May as senior vice president and national sales manager. About 70 existing AIM Investments sales professionals will serve as generalists, marketing the PowerShares family with AIM Investments' current offerings, Mr. Needles added.

AIM Investments isn't planning sweeping changes at PowerShares. The expense ratio for its ETFs, priced at a maximum of 60 basis points, will not change. PowerShares will keep its name. And Mr. Bond, PowerShares president and CEO, will continue in those roles, working in Wheaton with the 30 existing staff members.

Mr. Bond did not return calls by press time.

"PowerShares is a powerful identity, and we want to maintain that," said Mark Williamson, senior managing director at AMVESCAP.

PowerShares is a small operation compared with Barclays Global Investors, San Francisco, which had $199.7 billion in ETF assets as of May 31, or SSgA, with $90 billion in ETF assets as of March 31.

"PowerShares doesn't have to overtake Barclays or State Street … to see significant growth. The ETF industry is growing that fast," said Dan Culloton, senior mutual fund analyst at Morningstar Inc., Chicago, and editor of ETFs 100, a compilation of reports on the largest and most widely held ETFs.

The Investment Company Institute, Washington, said combined assets of the nation's ETFs were $334.9 billion on April 30. Earlier this year, Financial Research Corp., Boston, reported the ETF market is expected to grow 29% annually and will exceed $1 trillion by 2010. Celent issued a report on June 19 predicting the ETF market will reach $1.95 trillion by 2010.

"There's been a fair amount of excitement about PowerShares, but a fair amount of skepticism because the indexes are fairly new," Mr. Culloton said.

Only PowerShares' inaugural ETFs — PowerShares Dynamic Market Portfolio and PowerShares Dynamic OTC Portfolio — have achieved a three-year track record. The Dynamic Market Portfolio beat the Standard & Poor's 500 index by 7.27 percentage points on an annualized basis for the three years ended April 30, while the Dynamic OTC Portfolio beat the Nasdaq Composite by 6.99 percentage points on an annualized basis over the same time period, according to figures provided by PowerShares.

AMVESCAP and AIM officials plan to tout the new combination of offerings at a road show this fall in 24 cities.

The acquisition is expected to close in the next several weeks. PowerShares' shareholders already have approved proposals on 12 of 37 funds as part of closing the acquisition. The meetings on the remaining 25 funds have been adjourned until July 20 to provide shareholders additional time to vote their shares and the funds to achieve the necessary quorum.