Forget Liquidity, ‘Capacity’ Is Real ETF Concern

April 26, 2017

You’re in an elevator and it starts getting really crowded. You instinctively look over to the conveyance permit for the weight capacity of the lift. You count the number of people and multiply by, say, 150 pounds to see how close it is to capacity.

That’s sort of analogous to what concerns some in the ETF industry.

Capacity is currently much more of a concern for ETF issuers and portfolio managers than the much-talked-about myth of ETF liquidity. With the flood of new assets flowing into the ETF space—from $1.2 trillion five years ago to $2.8 trillion today—the concern that an ETF could get too big is not only prevalent, but has just played out again ...

This month, ETF.com’s Sumit Roy reported on how the VanEck Vectors Junior Gold Miners ETF (GDXJ) had become too big for its index, the MVIS Global Junior Gold Miners Index. The $4.8 billion ETF owns giant positions in its underlying holdings, putting it at risk of violating certain Canadian and U.S. regulatory thresholds for corporate ownership.

Buying Stocks Outside Its Index

To avoid crossing those thresholds as more assets piled into the fund, the ETF bought up stocks of companies that weren't in its index―creating a significant divergence between the ETF components and the index components.

VanEck (which runs both the ETF and the index) recently acknowledged the divergence by announcing it would broaden the scope of the index and include many more gold miner stocks in the portfolio at the next rebalance date.

What VanEck is doing is expanding the size of the potential pool of constituents by taking on bigger companies. Whereas the market-cap range of companies was $75 million - $1.6 billion previously, going forward, it will be $75 million - $2.9 billion. The fund is taking a step toward the midcap space as it runs out of small-caps to buy.

 

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