What You Need to Know
- A Direxion leveraged ETF will shut, while many others from the likes of BlackRock and DWS Investment are blocking new cash from entering.
- “We’re in uncharted territory here,” he said. “Two major index providers have effectively just told Russia that it’s on its own and that it’s stocks are worthless,” said Morningstar's Ben Johnson.
Major index providers are officially cutting Russian assets from their gauges, ratcheting up the pressure on an exchange-traded fund industry already facing an extraordinary stress test.
MSCI Inc. and FTSE Russell both said late Wednesday they’re removing Russian equities from some of their widely-tracked indexes a day after Stoxx Ltd. announced it will delete Russian companies from its benchmarks and close its country-specific gauge.
Firms including S&P Dow Jones Indices and JPMorgan Chase & Co. are still consulting on the matter, with decisions expected soon.
Given the chaos surrounding “uninvestible” Russian securities, the moves aren’t a surprise. But they further complicate the outlook for ETFs already suffering after sanctions and the Moscow market shutdown made their underlying assets virtually impossible to buy or sell.
U.S.-listed funds tracking Russian assets including the iShares MSCI Russia Capped ETF (ticker ERUS) and the VanEck Russia ETF (RSX) slumped on Thursday following the news, with several facing trading halts.
“What’s really being tested is market-place resiliency,” said Reggie Browne, co-global head of ETF trading and sales and a principal at GTS. “This is somewhat unique.”
The structure of ETFs mean they are still trading even with their assets stuck.
As prices plunge and valuations go haywire, one Russia-focused ETF is already being shuttered. Most others — including products from the likes of BlackRock Inc. and DWS Investment — are blocking new cash from entering.
Now, many passive vehicles can’t actually sell to comply with the index changes, handle investors exiting, or both.
“For ETFs such as broad global ETFs or even broad EM ETFs where the Russia holding is limited, the ETF I guess will continue to hold the Russian assets, tracking a benchmark where these are removed,” said Matthew Brennan, head of investment management at AJ Bell.
The idea is that the Russian securities would continue to be held even if valued at zero. This could cause tracking error — when a fund’s actual performance diverges from that of the benchmark it follows — but also has potential upside should the assets ever recover.
The positive news for the broader industry is that Russian securities generally make up only a small part of major developing-nation gauges. The country typically accounts for about 3% to 4% of emerging-market ETFs, according to Bloomberg Intelligence.
For instance the iShares MSCI Emerging Market ETF (EEM) had a geographical weighting of 3.56% for Russia as of Dec. 31. About 2.8% of the $79 billion Vanguard FTSE Emerging Market ETF (VWO) is in Russia.
“Given the small weighting of Russia on most global funds, the impact will be minimal,” BI analyst Rebecca Sin said.
“Excluding dedicated Russia trackers there are 33 US ETFs with at least 3% in Russia (mostly EM ETFs) equaling about $6.5b and they are all trading at a slight premium to their NAV with the exception of EM debt, those are trading at discount. Here’s a look at them via @tpsarofagis.”
— Eric Balchunas (@EricBalchunas) March 2, 2022.