The recent hiccups around the VanEck Vectors Junior Gold Miners ETF (GDXJ) have highlighted something few people talk about: what index managers actually do. And I think it’s genuinely underappreciated.
There’s a belief in some circles that managing a fund that tracks an index is like riding a bicycle: Yeah, you need to learn, but once you do, it’s just on autopilot.
Nothing could be further from the truth.
In no particular order, here’s what goes right every day in a solid ETF shop—which nobody ever sees—and what could go horribly wrong.
Compliance & Tax Recapture
It sounds boring—unless you’re on the hook for it—but ensuring an ETF meets any of hundreds of potential regulatory requirements, all day, every day, is not as easy as it sounds.
The recent GDXJ stories are an example of a fund getting it right. Yes, the fund was forced to deviate from its index because the size of its positions started bumping up against a 20% limit on ownership imposed by Canadian regulations. What was missing from a lot of the coverage is that this was a huge win for good management.
Consider the alternative. If Van Eck had been asleep at the wheel and just let some of its positions cross over the 20% threshold, it could have been a disaster. A raft of lawyers would have waded into the fray, filing for exemptions, or complying with the rules and making tender offers to thousands if not millions of shareholders.
The fund would almost surely have had to close for creations in the chaos.
The compliance burden for a big international ETF is enormous. From 2009-2013, Brazil—just to pick one example—was constantly changing the rules about foreign entities buying stocks, creating a near-daily shifting landscape for any ETF targeting that market.
Investing in China? You better make sure you’re staying on top of your (likely borrowed) renminbi qualified foreign institutional investor quota.
And that’s to say nothing of the combo-platter of U.S. regulatory issues even the simplest ETF faces: IRS diversification rules, SEC disclosure rules, exchange listing requirements, FINRA communications rules. It’s real work.
International funds have another wrinkle. Depending on which country an ETF is investing in, the dividends from the holdings may be subject to withholding. In many cases, those withholdings can be recaptured because of tax treaties between the U.S. and the target country.
How good you are at getting that money back can make a real difference, and who knows, you might be even better at it than the index provider itself outlines in its rulebooks.