The International Securities Exchange (ISE) recently announced its partnership with PureFunds in the launch of three new exchange traded funds (ETF), the PureFunds ISE Diamond/Gemstone ETF (NYSEARCA:GEM), the PureFunds ISE Mining Service ETF (NYSEARCA:MSXX), and the PureFunds ISE Junior Silver ETF (NYSEARCA:SILJ). All three ETFs track proprietary indexes developed by the ISE and are listed on NYSEArca. Kris Monaco took some time to speak with JLN Metals editor Sarah Rudolph about the characteristics and uses of these new products.
Q: How and why did ISE develop these indexes in conjunction with the PureFunds ETFs?
A: ISE developed the indexes over the past few months, after PureFunds approached us. They had interesting ideas in equity-only exposure to mining and hard assets.
When ISE became active in the ETF industry it was mostly by creating indexes that were equity-based in hard assets and natural resources, for example the First Trust ISE Revere Natural Gas ETF (NYSEARCA: FCG) is not natural gas futures but rather the companies exploring and producing natural gas. That was our first niche in ETF industry. We had success and recognition in those indexes, which became the basis for ETFs and ETNs.
When we were approached by PureFunds to design the indexes, it seemed like a good fit because that’s where we have experience. To date, we’ve developed over 30 ISE indexes, some of which are actually quite difficult to design. In this case, we first establish the purest possible definition of that space and then we start our research almost as if we were equity research analysts, calling IR teams if we have to and getting revenue segment numbers.
Though two of these sectors are widely tracked, we were being a bit more specific in the case of silver. We did not put every silver miner into the index, only junior miners – small-cap silver companies. With the Diamond/Gemstone index we’re really focusing on companies that have most of their revenue exposure to diamonds and gemstones.
It requires quite a bit of research and modeling to put a portfolio together that can be investable and tradable. Our Index Methodology Guides for each of the indexes include why a particular company was deemed to be in that space and how they are weighted in the index – in essence, the influence a company has at times of rebalancing. In this case we give more influence to companies with more exposure to the defined theme. We create factors that determine which is a pure play and which is a non-pure play and try to come up with the most investable portfolio.
Q: What is your criterion for a pure play vs. a non-pure play?
A: When you are considering, for example, which of two gold companies to put in a gold index, it’s how you conclude which company is more related to gold. We come up with a method to evaluate that, which might include revenue exposure, exploration, how much of their activity is derived from gold mining and production. We come up with a revenue percentage threshold, and any company whose activity is greater than that number we deem a pure play.
Some companies with huge market capitalization derive their revenues from gold but also derive a large percentage from other areas. That will greatly influence the stock and therefore the index.
Q: Why did you choose to have the silver and the gemstone indexes track the small cap companies rather than the larger ones?
Junior gold mining has a huge following, so it made sense that there should also be a reference for junior silver miners. A lot of investors follow silver stocks, so this gives silver its own benchmark. We thought the popularity of the junior gold would transfer well to junior silver.
Q: Gold and silver ETFs seem to be quite popular now. What are the benefits of investing in precious metal and mining ETFs?
A: In terms of mining services it’s about the overall activity within the broader mining industry. With silver, in this case it’s about the implied leverage you get from companies that have exposure to that commodity. How much silver they pull out of the ground adds that component of leverage. If a company is making money producing silver, the amount of extraction will dictate their returns, so the greater the production the greater the returns. So you can get leveraged exposure to the commodity by investing in the companies that explore for them.
Q: What is your relationship with PureFunds? How did you come to get together with them on this venture?
A: Right now in the ETF industry, in order to issue ETFs, a registered investment advisor must seek exemptive relief from various provisions of the 1940 Investment Company Act. An advisor can bring in partners to work with them to come up with investment ideas. Factor Advisors, the sub-advisor to PureFunds, was seeking to bring in additional partners to help launch those funds. As part of the arrangement, PureFunds is obligated to pay costs associated with maintaining operations in those ETFs, rather than Factor Advisors taking on that obligation.
Separately, we have an agreement with PureFunds where we help pay those costs. This is part of a larger initiative we have in which we provide the underlying indexes for the ETFs and are also willing to put up startup capital to launch the ETFs.
Q: Do the current difficulties in the mining industry – higher costs, smaller profits – make the service sector a safer investment than investing in mining companies themselves?
A: Our goal with the mining services index was to have something related to the mining industry but not dependent on one specific commodity. We think it has its own dynamic. There is an oil and gas services benchmark and funds with billions in assets tied to that. Fortunes rise and fall with miners, but since the sector involves a few different commodities, it is more diversified.
Q: I read that the Diamond/Gemstone ETF will be the first ETF ever to hold shares exclusively of companies in the diamond and gemstone industry. Is there something that makes now the right time to launch such an ETF?
A: It is a unique ETF, but then I think all three of these new ETFs are pretty unique. The Gemstone ETF captures attention because this is a major area within mining and exploration that has not yet been focused on specifically. We thought that was a huge gap in the ETF industry. Also, another firm has recently filed for a physical diamond trust. We feel our products will be complementary. People are interested in both the ETFs that hold physical gold and the ones that hold mining stocks. They are complementary in holdings and in their return profiles as well. Because there is so much interest in physical diamonds we thought it was important to have an equity exposure play too.
These were ideas brought to us by Purefunds that we felt strongly about. They came to us for index expertise and we came back with indexes and venture capital support, and also guidance from a marketing and product design point of view.