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Exchange traded funds climbed to prominence on their promise of a low-fee, broad-based approach with a relatively safe path for investors who followed a long-term, buy-and-hold regimen.
However, data from TrackInsight suggest that advice might need updating. The findings show that 11 per cent of ETFs have changed the index they are benchmarked against in some way, and that on average those that did so made the change 5.6 years after they launched.
“The results are interesting and give some valuable information in my opinion. They show that investors should read any communications from their ETF provider carefully and make sure they understand the impact of benchmark changes on their portfolios’ exposures,” said Anaëlle Ubaldino, head of ETF research and advisory at TrackInsight.
The company looked at 7,228 passive ETFs and screened them for evidence that they had started tracking their current benchmark at a more recent date than their creation, implying a change was made over the life of the fund.
The research included all passive ETFs that have been created since the first was launched in the early 1990s, including those that have been wound up. Ubaldino noted that it counted each share class — for example, accumulation, distribution and currency-hedged versions — separately.
Just occasionally there has been an extreme change, such as in 2017 when the Tierra XP Latin America Real Estate ETF (LARE), an ETF investing in Latin American real estate investment trusts, announced it would change to tracking an index of cannabis companies — relaunching itself as ETFMG Alternative Harvest ETF (MJ).
However, Elisabeth Kashner, director of ETF research and analytics at FactSet, a data provider, said not all changes were a cause for concern.
An index change could be as minor as introducing caps on the weighting of the top five constituents or the addition of a currency hedge, Kashner said. Sometimes the index change will be to make the holdings more tax advantageous for the holder.
“I don’t think index changes can all be painted with the same brush,” said Kashner, adding: “If you want to make a dramatic change then, by God, do it in the daylight.”
There is no suggestion that investors are not informed when changes, however minor, are made to the ETFs they hold. However, the buy and hold reputation of ETFs could mislead investors into thinking that the vehicles need less scrutiny — an attitude that industry figures argue would be misguided.
Kashner advised investors to differentiate between the different kinds of ETFs they might own, noting that index changes, which FactSet defines as “soft closures”, are more common in narrow exposures.
Broad diversified funds are designed to be buy-and-hold funds, she said, and are less likely to affected by “idiosyncratic risks”. A tactical portfolio would need more frequent checks, but if it was designed with strategic intentions her advice is to “stick to the plan”.
Michael John Lytle, chief executive of Tabula, an ETF provider, said investors should, at a minimum, do annual due diligence on their ETFs. He said it would be too easy to assume that if you bought the ETF from a reputable platform that it would do those checks for you.
As well as looking for how an index might have changed, he advised investors to check tracking difference. Basically, he said, investors should be looking to see if they get the benchmark minus the management fee. “It’s the quickest way to check if the manager is delivering,” Lytle said.
“As an investor it’s good financial hygiene to look at your portfolio once a year and remind yourself why you own stuff,” he added.
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