Incorporating ETFs of any sort into a portfolio offers efficiency on many fronts, including better diversification, an easier client user experience and better leverage of a financial professional’s time devoted to tasks needed to maintain and grow a practice.
Being in the actively managed ETF space, we understand that advisors must pay close attention to manager changes and strategy changes. However, some advisors may not realize that they need to take the same care and due diligence regarding the construction of newly created indexes, as well as when an ETF sponsor decides to change an underlying index for a fund.
In late May, a curious price action occurred in the stock of Hanergy Thin Film Power Group, a Chinese solar company whose primary listing was on the Hong Kong Stock Exchange. After more than a 500% share price gain in less than one year, the foreign stock fell 47% in a matter of minutes on May 20. By virtue of its explosive growth, Hanergy had come to have a 12% weighting in a solar-themed ETF. While the stock’s meteoric ascent contributed to that ETF’s rise, the trading on May 20 led to an approximately 7% single-day drop for the fund. Awareness of any individual stocks with positions large enough that can cause such a significant decline for a fund is a crucial part of successfully implementing an ETF strategy.
In August 2012, Vanguard removed the MSCI index that underlay its emerging market ETF and replaced it with an emerging market index from FTSE. Interestingly, the same MSCI index still underlies iShares’ emerging market fund. Since the switch, the difference between the two indexes has been meaningful. For the 12-month period ending April 30, the fund tracking the FTSE index outperformed its counterpart by 335 basis points.