Investing in stock market activity is one way for clients to capitalize on world economic growth without having to predict which individual companies will be the winners. As long as there’s trading action, the exchanges and those who own them will make money.

Holdings in securities exchanges around the world are boosting the performance of a couple of funds run by Caldwell Investment Management Ltd. of Toronto.

“Ownership of stock exchanges is the best way to participate in whatever is going right in a nation or region’s economy,” says Brendan Caldwell, president of Caldwell Investment Management. “Good ideas lead to successful businesses that become listed on exchanges. The beauty is that you don’t have to predict which industries will be successful or whether stock prices will go up or down. Exchanges are driven by trading volume, and if you’re bullish on the world, they’re a great way to play it.”

Among the Caldwell offerings riding exchanges is Caldwell Growth Opportunities Trust, which was introduced in September 2005 and posted a one-year return of 28% as of March 31, based on investments in a mixed bag of securities exchanges around the world trading in stocks, options and futures. They include NYSE Group Inc., American Stock Exchange, Chicago Board Options Exchange, and others in Hong Kong, Johannesburg, Montreal, London and Philadelphia.

But although Caldwell Growth Opportunities Trust is restricted to accredited clients, Caldwell Exchange Fund, introduced last July, is available to a broad range of clients with its $500 minimum investment. This prospectus-sold fund is currently offered only in Ontario, Alberta and British Columbia, but is expected to be available in all provinces except Quebec sometime this month. It has shown a 64% return in the nine months since its inception.

Caldwell Exchange Fund is similar to Growth Opportunities Trust in that its portfolio is riding on the growth of an assortment of global securities exchanges as they transform themselves into for-profit, demutualized, publicly traded companies, although it may also invest in financial services companies generally. However, because of the regulatory requirements governing prospectus-sold mutual funds, Caldwell Exchange Fund’s holdings are concentrated on the shares of entities that have already gone public.

Caldwell Growth Opportunities Trust, on the other hand, can invest in memberships or seats of privately owned exchanges. For example, it has benefited handsomely from holding seats on the New York Stock Exchange, bought privately before they were converted into public shares. The fund will continue to seek opportunities to invest in exchanges prior to a public offering.

The caveat is that these Caldwell funds have an extremely narrow focus, says Mark Chow, senior analyst at Morningstar Canada in Toronto. And with the shares in some securities exchanges already showing some huge gains in value, he questions whether lofty expectations have already been built into their valuations.

“These funds are specialty funds, and are even more concentrated than some other specialty funds that diversify across a handful of industries tied to a sector,” says Chow. “Although securities exchanges are leveraged to growth in global equity markets, they are riskier than playing the same theme through index funds that are broadly diversified and less volatile. As exchanges become public companies, the risks also become company-specific and performance depends on profitability.”

Caldwell, along with his father, company chairman Thomas Caldwell, has watched the unfolding of the exchange investment story since the Toronto Stock Exchange went public five years ago and significantly enhanced the value of the single seat owned by affiliated firm Caldwell Securities Ltd. In addition, shares in a Caldwell-controlled, publicly traded company called Urbana Corp. have risen sharply in the past couple of years because of holdings in various stock exchanges, although your clients interested in investing in Urbana should realize they can trade their shares only at current market value and they are not redeemable at net asset value as are mutual funds.

Caldwell believes the trend has a long way to go before it will be played out. More privately held exchanges around the world are going public and becoming profit-oriented corporations rather than clubby, non-profit organizations owned by the securities dealers who trade through their facilities. The profit motive makes the exchanges more efficient and often leads to mergers, acquisitions and innovative products such as exchange-traded funds, Caldwell says.

@page_break@Still private are the Chicago Board Options Exchange and several major stock exchanges, including the dominant exchanges in Tokyo, India and Ireland. Making an early investment in an exchange by buying seats or private securities before an initial public offering can pay off handsomely.

“We’re about three innings into a nine-inning game,” Caldwell says of the trend that includes securiti-zation, accelerated growth and takeovers by strong regional leaders as globalization leads to convergence.

He considers exchanges as similar to utilities or a “toll road” on the financial activity of a nation or region. They benefit from listing fees, trading activity and revenue from the supply of data and information. Once the basic infrastructure is in place, costs don’t increase proportionately to the volume of traffic, although exchanges must invest to stay competitive in terms of technology and efficiency. With increasing globalization and technological innovation, Caldwell says that he expects trading volumes to increase. Powerful stock exchanges can take advantage of the rapidly expanding markets for alternative securities such as futures and options.

An example of this kind of expansion is the recent agreement by the TSX Group Inc. to hook up with U.S. derivatives giant International Securities Exchange Holdings Inc. The plan is to compete head-on with the Montreal Exchange, which currently controls derivatives trading in Canada, by launching a new exchange for futures and options. The new bourse, to be called the DEX, will open in March 2009, after the expiration of a non-compete deal between the TSX and the Montreal Exchange.

The new exchange, which will require an initial investment of $26 million, will be 52% owned by the TSX and 48% by ISE. For its part, the Montreal Exchange recently joined forces with the New York Mercantile Exchange to start a new energy futures market.

Both the ME and the TSX are positioning themselves to become dominant players in the lucrative and high-volume derivatives market. Partially spurred by hedge funds, derivatives trading has been growing even more rapidly than regular share trading, with the Montreal Exchange enjoying annual volume increases of about 30% a year since 2000.

Caldwell says he and his family didn’t immediately grasp the profit potential of exchanges going public, although they had a front-row seat on the first public offering of a major North American stock exchange through ownership of their seat on the TSX (then the TSE), which was bought by Caldwell Securities in 1980 for $30,000.

“At that time, a seat was regarded simply as a vehicle for a brokerage firm to trade stock — a means to an end,” Caldwell says.

By the late 1990s, when the TSX commissioned a study to persuade the membership that demutualization was a good thing, seats on the TSX were changing hands at $50,000, which, Caldwell says, was less than a taxi licence at the time and should have been a tip that the seats were undervalued.

The study estimated that seats in a publicly traded TSX would be worth $2 million each. But when the TSX actually went public and became TSX Group Inc. in 2002, its 122 members received shares worth $4.5 million for each seat. The value of the shares has since risen to the equivalent of about $25 million for each seat but, Caldwell says, 70% of TSX membership sold its stock into the IPO. The Caldwells have hung on to most of their shares, but “didn’t do as well as we could have” if the entire position had been maintained, Caldwell says.

However, there is some consolation in the fact that the TSX shares they continue to hold are worth more than the entire position at the time of the public offering, according to Caldwell.

When the New York Stock Exchange decided to go public, that was their chance to “do-over,” Caldwell says, and participate as owners of an exchange that trades 10 times more volume than the TSX and is the world’s biggest bourse. The Caldwells bought their first seat on the New York exchange in mid-2003 at record high of US$2 million and subsequently watched the value drop to US$1 million.

Through various vehicles, including Urbana Corp. and several limited partnerships, the firm loaded up at cheaper prices, accumulating a total of 49 of the 1,366 New York seats by the time the exchange went public in 2005. Caldwell was the second-largest owner of seats after USB AG Bank of Switzerland. Each seat owner received a package of shares worth US$5.5 million at the time of the offering, which is currently valued at about US$7 million a seat.

“Buying seats was an arduous process that required a lot of detailed work and everything up to fingerprinting, “ Caldwell says. “But we believed the owners of New York seats were suffering from the same myopia that we had experienced regarding the potential gains in exchanges becoming public companies motivated to make a profit.”

Operating profit margins at the NYSE have risen to 25% from 4% since it went public and became profit-oriented, Caldwell says, because of technological efficiencies of electronic trading, cost-cutting and increased revenue from proprietary products. IE