Talking ETFs, China, and Intellectual Property With Claymore’s Christian Magoon

by on August 25, 2009 | Updated August 26, 2009 | ETFs Mentioned:

Christian Magoon is the President and Senior Managing Director of Claymore Securities, Inc. He recently took time out of his busy schedule to talk with ETF Database.

ETFdb: It’s been a good year for the ETF industry, and Claymore in particular. Obviously the equity markets have had a pretty strong rebound in 2009, but also strong cash inflows have increased the size of the ETF market. Data from the¬†National Stock Exchange indicates that Claymore has seen cash inflows of more than $635 million this year. Are there any sectors or funds that you’ve seen as especially popular among investors this year?

Christian MagoonChristian Magoon: We’ve seen a lot of share growth as well as AUM [assets under management] growth this year. Through August 14th, we’ve seen our shares grow about 64%, which translates into about 39.5 million shares. Our AUM growth has also been very strong at over 118% through August 14th of this year. In terms of an absolute number, our AUM is up about $1 billion. So we’ve certainly seen some great growth across the board.

In terms of what has really been leading us and overall creations, we’ve had a lot of interest in our China ETFs, the Claymore/AlphaShares China Small Cap Index ETF (HAO) and the Claymore/AlphaShares China Real Estate ETF (TAO). We’ve also seen a lot of interest in the Claymore/Zacks Multi-Asset Income Index ETF (CVY), and the Claymore/BNY Mellon BRIC ETF (EEB) has been very strong. In addition, the Claymore/MAC Global Solar Energy Index ETF (TAN) has done nicely.

It’s interesting to note that we are at our all time high in terms of shares outstanding, but we are about 15% off of our all time high in terms of AUM. So we’ve seen very strong share growth that’s translated into strong AUM growth, but we are still below the NAVs that led us to our all time high in terms of outstanding AUM.

ETFdb: You touched on Claymore’s China ETFs. When we take a look at some of the best performing ETFs year-to-date, two funds that Claymore offers — the Small Cap Index ETF (HAO) and the Real Estate ETF (TAO) — are near the top of the list. Why have these funds performed so well this year, particularly in comparison to their U.S. counterparts?

CM: Let’s talk about TAO first, which is the Claymore/AlphaShares China Real Estate ETF. Here you have the world’s largest country in terms of population seeing a vast migration of people from rural to urban areas and an unprecedented amount of building and construction. These trends are really fueled by demographics and urbanization, which is very different from many of the trends that fueled, for example, the U.S. housing industry.

There are some very lofty figures that are quoted about the amount of square feet that are projected to be built in China over the next five years when you look at office and residential real estate. I don’t think there has ever been that much square footage ever built before in any nation. So this is a mega-trend that is happening, and for that reason I think the real estate market in China is very different than certainly any developed real estate market. This ETF invests in companies that own, manage, or lease land in China, Hong Kong, or Macau, the epicenters of where this migration is occurring.

As of August 14, TAO was up 61.49% vs. FXI, the largest Chinese ETF, which is primarily large caps, at 42.36%. That’s nearly a 50% difference in performance.

ETFdb: What about HAO?

CM: The other fund we have, HAO, has attracted more interest in terms of assets, and is really the first and only Chinese small cap ETF.¬† You generally think of deriving greater returns from small cap companies, but you also see more risk or greater volatility. I think that’s what we are seeing in China: the smaller businesses have, in this case, greater volatility on the upside that has translated into better performance.

In addition, when you look at the composition of HAO versus FXI, there are some very real contrasts. FXI is based on a very large-cap oriented index that tends to focus in on state-owned companies. These state-owned enterprises aren’t always run for the maximum benefit of shareholders, and they don’t often exhibit the same entrepreneurial spirit that really exists in smaller companies in China. So I think that the makeup of the companies, as far as who actually owns them, has also driven some of the performance.

I think the point of these two funds is that China is a massive country in terms of population and GDP, and eventually, we believe, will overtake much of the developed world as the world’s largest economy. Yet many people do not have a lot of exposure to China and many investors’ exposure to China is basically limited to the largest cap stocks, or the most liquid names out there. Many of those names are state-owned enterprises that aren’t consumer oriented, meaning investors don’t get well-diversified exposure.

We think there is a huge gap there. An investor in the U.S. would likely not just own the top 25 or 30 largest market cap companies, he or she would own mid-caps and small-caps, as well as some sectors. We think the same is true for China, and that really propelled the launch of the first two products in our China suite. We believe that they provide diversification to investors who are looking for exposure in China.

ETFdb: You mentioned the two China products in the existing suite. We see that you filed for another ETF based on another AlphaShares index. How would this proposed fund be different than the current China ETFs available to investors?

CM: We publicly filed for another ETF which would be the first China All Cap ETF, giving investors the ability to own large, medium, and small companies in China in one investment. I can’t really get into the details of this because it hasn’t launched at this point, but as the public filing states, it is an all-cap that we think will provide an attractive way to diversify investors’ portfolios in one ticket.

ETFdb: A couple of the Claymore ETFs that we find particularly interesting are the funds that you have with Ocean Tomo, the Claymore/Ocean Tomo Patent ETF (OTP) and the Claymore/Ocean Tomo Growth Index ETF (OTR). Could you explain the methodology behind the composition of these products and how that might lead to superior returns?

CM: Forty or fifty years ago, companies were valued based off the inventory they had, the equipment they owned, the real estate they sat on, the facilities that they had — basically their hard assets. But our economy has changed so dramatically that a lot of the most valuable assets a company has is not hard assets, but rather the intellectual property or the patents it owns. So we partnered with a firm, Ocean Tomo, that is a leading evaluator of patents to create two different indexes. The first focuses on a broad based patent valuation — basically the patent value of a company to its book value, the second is more focused on a subset of growth companies within the overall universe.

So why does a Microsoft or a Cisco or a Dell buy a company you’ve never heard of for hundreds of millions of dollars? It’s generally because they have patents that are extremely valuable, and as we’ve progressed technologically, more patents have been issued, and those patents often times can make up a majority of a company’s value. So the investment thesis behind these products is that intellectual property is a significant driver of a company’s valuation. These funds look for companies that are relatively inexpensive based on the ratio of the value of their patents to their book value.

Since inception, the broad based patent index has achieved about 400 basis points better performance over the S&P 500 and the more narrow growth index has achieved about 100 basis points better performance than the Russell 1000 Growth Index. So again these are alternative ways to value companies and more of an updated approach than valuing based on hard assets or inventory or land, and we think that based on the performance since inception, that’s a valid investment thesis.

Be sure to check back tomorrow for the second part of our discussion with Christian.