When An ETF Changes Its Exposure

November 08, 2017

On Oct. 27, ETF Managers Group (ETFMG) filed for a new ETF, the Alternative Agroscience ETF, a first-of-its-kind fund to track the burgeoning legal marijuana industry.

Except the Alternative Agroscience ETF isn't precisely a new fund.

Instead, ETFMG is retrofitting an existing ETF, the Tierra XP Latin America Real Estate ETF (LARE), with a new strategy. Effective Dec. 26, LARE's index will change from a Solactive benchmark that tracks mostly Mexico and Brazil REITs to a Prime Indexes benchmark tracking cannabis cultivators, producers and distributors, as well as cannabinoid drug makers, fertilizer producers and tobacco companies.

The Alternative Agroscience ETF would be the first marijuana ETF to come to market in the U.S. As such, its first-mover advantage could be significant.

"As an issuer, we've seen increasing demand from investors looking for solutions to gain access to this space," said Sam Masucci, chief executive officer and founder of ETF Managers Group, the fund's investment advisor.

But the index transition also means radically altering LARE's focus and risk/return profile, as well as eliminating the market's only pure-play Latin American real estate fund.

The move has left some investors fuming.

"I think it's a little scummy what they're doing," said Peter DeCaprio, portfolio manager and principal at Crow Point Partners, in Hingham, Massachusetts. Crow Point is the largest investor in LARE, owning a 22% stake, according to most recent 13-F filings.

"But as long as they have support at the board level, if they want to change up the strategy, then they can," he added.

Changing Indexes Not Uncommon

This isn't the first time an issuer has changed the index backing one of its funds. It's not even all that uncommon. ETF.com lists hundreds of such instances since 2003.

"Index changes aren't as rare as people think," said Kris Monaco in an email. Monaco is managing partner of Level ETF Ventures, which owns and operates Prime Indexes, the index provider of the new Alternative Agroscience ETF. "It demonstrates the robust nature of the industry, and the need for both issuers and index providers to continue to innovate."

Typically, issuers attempt to maintain some consistency between an old and new index. Though index providers may change or the securities universe may be tweaked, a small-cap ETF will generally remain a small-cap ETF, a tech fund a tech fund, and so on.

But not always. Sometimes changing a benchmark effects dramatic change on the ETF, transforming large-cap ETFs to small-cap ones; or switching focus from one single-country market to another; and so on.

One of the most radical changes was in 2013, when Exchange Traded Concepts made an index change to its Canadian oil sands ETF that transformed it into an income-focused fund-of-funds. The ETF gained a new name, the YieldShares High Income ETF, and a new ticker, YYY (see: "First Yield-Focused Magoon ETF Goes Live"). Monaco was also involved in the YYY change.

Low Assets Can Prompt Change

Usually, the ETFs chosen for change tend to be extremely low in assets and average trading volume. For example, the YieldShares Canadian oil sands ETF had less than $1.5 million in assets when it transitioned into YYY in 2013 (today it has $207 million).

LARE has also failed to gain significant market traction. As of Nov. 1, it had $6.0 million in assets and an average daily volume of $90K.

"There's a need to make sure a fund resonates strongly with investors, that it's solving a portfolio allocation problem," said Masucci by email.

 

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