ETF Index Swaps: More Common Than Investors Think?
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ETF investors might be surprised to learn that the index they thought their funds were tracking has been swapped out for another.
According to a recent Morningstar report, about 25% of index-tracking mutual funds and ETFs have changed their target index at least once since inception.
The study, which examined roughly 1,200 index-tracking funds, found that 310 had switched their target index, with some funds making multiple changes. In total, those funds made 374 index changes.
“Active decisions can still squeeze their way into index-tracking funds,” report author Daniel Sotiroff, senior analyst at Morningstar, wrote in the survey.
ETF Index Changes: Not All Created Equal
The impact of the changes varies widely, the report found. About half of the index switches represented minor adjustments that didn't substantially alter the fund’s risk/reward profile. These often occurred in larger funds, with 36 out of 55 funds in the low-tracking-error cohort having more than $500 million in assets.
However, smaller funds were more likely to make dramatic shifts, Sotiroff said. Of the 42 funds that had more than 3% tracking error between their old and new indexes, 32 had less than $500 million in assets.
Invesco, BlackRock's iShares and Vanguard were among the providers with the most index change, likely due to their large fund lineups and long-standing presence in the market, the report notes.
The reasons for changing indexes vary, with some switches aimed at cutting costs through lower licensing fees or improving trading efficiency, while others represent larger shifts in investment strategy.
For instance, the Invesco S&P 500 GARP ETF (SPGP) switched from the Russell Top 200 Pure Growth Index to the S&P 500 growth at a Reasonable Price Index in June 2019, the report said. The tracking error between these indexes was nearly 7% over the five years prior to the change, reflecting a shift in strategy.
The report found that most funds didn’t attract much new money after changing their index. About 43% of funds saw outflows in the 12 months following the switch, while 35% took in $100 million or less.
Sotiroff advises investors to monitor prospectus documents and amendments for such changes, noting that index switches tend to occur early in the fund’s life, with a median time of five years before the first change.