Know Your ETF Constituents

The two indexes have differences in country and sector weightings, which likely account for the dispersion. For example, the FTSE index omits South Korea, a country market that has underperformed over the last year and has a large weighting in the MSCI index. It’s critical that advisors understand how a fund’s underlying index is constructed, and that they stay informed of any changes to an index to successfully implement the level of risk clients are willing to take in their investments.

It has been almost one year since Bill Gross resigned from PIMCO. He, of course, has been known for many years as the “Bond King,” co-founded PIMCO and managed numerous funds across various product structures—ETF, closed-end fund and traditional mutual fund—for the firm. Since Gross’ PIMCO departure, both the ETF and traditional fund versions of the Total Return fund he was most known for have lagged behind the Barclays Capital Aggregate Index. In the year before his departure, the ETF outperformed while the traditional mutual fund lagged.

So much was written, discussed and analyzed about the Gross resignation. Many investors understood this was a trigger to reconsider their allocation to the strategy. Some investors had concerns and redeemed, while others felt comfortable with the existing team and chose to stay in the strategy. It seemed clear that many fiduciaries understood their role was to look closely at their clients’ allocations and make a decision on their behalf.

We do not see this happening with index ETFs as not all broad market exposure is the same, and returns and risk profiles can be very different from each other. While ETFs have blurred the lines for index investing by dramatically expanding what can be defined as an index, one thing is becoming more certain: Advisors are learning to treat new index ETFs similarly to active strategies, and to know which underlying ETF constituents their clients own.