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Exchange-Traded Pioneer Forges Ahead


Nathan Most has always been willing to take on problems that on the surface appeared to be mundane. But as the former physicist has delved into each challenge, he often found himself at the forefront of an astounding development, anything from inventing sonar to detect enemy German submarines during WWII to masterminding the Spider, the first exchange-traded fund.

Most is impressive when he speaks to an audience of young, exchange-traded fund developers, marketing executives and lawyers at conferences on the subject. All listen attentively to the 86-year-old rattle off details on the trading intricacies of the hottest new product to hit the mutual fund scene in years. Any conversation with Most is also surprising, as he is more than likely to be interrupted by a call on his cell phone from someone at Barclays or at an exchange from the far reaches of the globe.

"It's kind of natural for them to wonder," Most said. "Everyone thinks all of the ideas come from the young people. But at Barclays, we are still pushing the envelope on the iShares," the 56 exchange-traded funds being sold by Barclays Global Investors of San Francisco.

Most is still an integral part of the emerging exchange-traded fund scene. While Most has had five very different and successful careers in his life, he has no plans to retire. Most is currently president and chairman of iShares, the investment adviser to the funds. He is also president and chairman of the funds' board of directors.

In that capacity, Most is currently focusing on solving some of the operational problems of exchange-traded funds based on foreign indexes in markets that are closed when U.S. investors are open. A major problem is determining at what price U.S. investors should be able to purchase these foreign funds.

"Unless you can flatten out the earth, it won't be an easy solution," Most said.

Another problem is that some of the newest exchange-traded funds are based on indexes with very few stocks in them because in some countries, there are very few stocks in which to invest, he said.

In addition, some countries (including Taiwan, Malaysia and Brazil) prohibit funds from redeeming shares in securities, as exchange-traded funds generally do, Most said.

In addition, in the U.S., SEC and IRS regulations require funds to have designated representation of particular sectors, compelling some exchange-traded fund managers to buy stocks they would prefer not to own, Most said. Most is now concentrating on these problems, as well as traveling extensively, particularly to the Far East, to meet with stock exchanges that want to list exchange-traded funds, Most said.

Most is not involved in developing actively-managed exchange-traded funds, although he believes these funds will one day dominate the mutual fund industry.

"It'll take a long time," said Most. "We have only scratched the surface on these things. . . . But in the long run, ETFs [will rule] because they have everything a mutual fund has, and more. They will gradually take over."

Still, Most never expected that the first exchange-traded fund that he developed would lead to a whole new investment category, he said.

"This thing has kind of taken off," Most said.

Most was head of product development at the American Stock Exchange in the late 1980s, charged with the task of building its daily trading volume from 20 million shares a day, he said.

"That's peanuts today," he said. The Amex was losing listings and trading business to the venerable New York Stock Exchange and the Nasdaq upstart, Most said.

"The whole situation at the Amex was challenging. It was a whole new field for me," Most said. Undaunted, Most focused on the increasing popularity of mutual funds and index funds in particular.

He contemplated adopting the commodity trading model to the mutual fund industry to create a new product to be sold on the Amex. In doing this, he drew on one of his many careers - trading safflower seeds and coconut oil future.

"I thought, 'They're popular," he said. "Why can't we trade those?' I have always been the kind of guy, when I see a problem, I want to fix it. I took a crack at it, and as it turns out, the exchange-traded funds, particularly the QQQ [an exchange-traded fund that tracks the Nasdaq 100 Index] is now very important to the Amex. Daily trading volume of regular shares on the American Stock Exchange have dropped to 15 million shares a day, but ETF volume, which averages 35 million shares a day, has boosted daily volume on the Amex to 50 million shares a day."

While, overall, the $50 billion of assets currently invested in the 69 exchange-traded funds on the market may seem small, it is very important business for the Amex, Most said. Most believes that exchange-traded funds will become ubiquitous.

The regulatory environment and technological advances in processing trades also were integral to the introduction of the Spider in 1993, Most said. Following the stock market crash in 1987, institutional investors and the SEC began looking for a hedging investment other than derivatives, Most said. They saw exchange-traded funds as a safe alternative, he said.

At a meeting in the basement of the SEC in 1992, Richard Breeden, chairman of the SEC at the time and a personal friend of Most's, told his staff members that he wanted "this thing passed," Most said "Well, it took a year."

But the execution of an exchange-traded fund transaction, essentially the instantaneous purchase of a basket of an index of as many as 500 stocks, would never have been possible had the operational back-office systems not been developed, Most said.

"I'm going to be staying with ETFs, and looking at what we can do to make them better," Most said.