How An ETF Gets Too Big For Its Index

April 10, 2017

ETF Deviating From Index
In an attempt to try to ameliorate the concentration issues it’s facing, the ETF now has five holdings that aren't index constituents, representing 25% of GDXJ's portfolio, according to BMO Capital Markets. One of those holdings is the VanEck Vectors Gold Miners ETF (GDX), another product from the same issuer, which focuses on much larger gold companies.

Chris Kwan, mining specialist at BMO, believes GDXJ has simply gotten too big for its benchmark now that it is a $5 billion ETF "attempting to invest in a ~$30B gold universe."

In Kwan's view, there are three ways forward for the ETF. It could continue with the status quo, creating uncertain and volatile quarterly rebalances; it could sell its nonindex gold stocks and increase its position in GDX; or it could expand the allowable market-cap size of the ETF.

Moving Beyond Junior Gold Miner Territory

In a way, the ETF has already de facto expanded the average size of its holdings. The nonindex names that it owns have the biggest weightings in the fund. That includes GDX, which has a weighted average market cap of $9.3 billion―well beyond small-cap, junior miner territory.

Perhaps the easiest fix for VanEck, which also develops the underlying index for GDXJ, is to expand what it considers to be the junior gold miner universe, something the issuer did in 2014 when faced with a similar situation. Why hasn't this happened already? That may be because the portfolio managers are holding out hope that, at some point, they can go back to employing a full replication strategy.

As Scotiabank points out, if VanEck expands the universe too much, the market cap for some of the holdings in the ETF would breach $2.5 billion, a level often used to define small-cap stocks. That's not necessarily a horrible thing, but it would take the ETF further away from offering the junior gold miner exposure that it promises.

VanEck wouldn't comment on its portfolio management decisions for this story, but said that "it continues to manage GDXJ so it meets its investment objective" even though "there may be times when certain market and regulatory factors affect the ability of GDXJ to own certain securities or own them in proportion to their index weightings."


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