Why Do ETFs Change Indexes?

July 09, 2019

Which ETFs Get Retrofitted?

For issuers, the cost/benefit analysis is clear: Retrofitting an existing structure with a new index is faster and less expensive than filing for a brand new fund. Taking a new ETF from concept to launch can run anywhere from $75,000 to $100,000. Retrofitting an existing fund costs about half that, by one issuer estimate.

Usually, the ETFs chosen for retrofitting tend to be low in assets and in trading volume. For example, when the decision was made to transition LARE from Latin American real estate to marijuana, the fund had only $6 million in assets and an average daily trading volume of $90,000.

Likewise, before the Defiance Future Tech ETF (AUGR) became the Defiance Next Gen Video Gaming ETF (VIDG), it had just $3.6 million in assets and an average daily trading volume of $1,900.

Because the targeted funds tend to be so low in assets, issuers rarely see a significant outflux of investor assets exiting their funds when the indexes eventually switch.

The right index switch can attract massive assets, however. Less than two weeks after its index change on May 29, the First Trust Indxx NextG ETF (NXTG) pulled in more than $100 million in new net inflows. (And of course, the post-switch MJ is now far and away the largest marijuana ETF on the market, with $1.1 billion in assets under management.)

That said, swapping an index is no guarantee that investor assets will come. For every MJ and NXTG, there are many more like GRMY, whose index switch failed to attract enough assets to save it from eventual closure.

Investors Get No Input

Complicating matters is the fact that investors do not have say into changes made in their funds' indexes, due to the way the Investment Company Act of 1940 was written.

The law governs "investment policies" of registered investment companies, including mutual funds and ETFs. (An example of an investment policy is a fund's investment objective, which often states its index by name.)

There are two kinds of investment policies: "fundamental" and "nonfundamental." A fundamental policy requires shareholder approval to change, while a nonfundamental one only requires at least 60 days’ written notice to investors.

ETF issuers may decide for themselves which investment policies they consider fundamental, thus requiring a vote from shareholders. Benchmark indexes usually don't make the cut.

As a result, when an issuer wants to change an ETF's index, no matter how drastically, usually all that's required is written notice to investors two months' ahead of the scheduled switch.

Performance Charts May Remain The Same

Investors should be aware that issuers can and usually do continue to point to an ETF's former track record in its prospectus and marketing materials for its new incarnation.

From an issuer's point of view, this can benefit untested ETFs, especially if the previous version of the fund had solid performance.

However, these historical performance charts can be misleading for investors, especially those unaware of the index switch and/or who do not know to look for the fine print.

As always, investors should vigilantly research every fund they invest in—especially ones for which they've recently received notice of an index change. Because when these changes occur, there's no guarantee that what your fund holds today is what it'll hold tomorrow.

Contact Lara Crigger at [email protected].

Find your next ETF

Reset All