Last month the US securities market regulator, the SEC, changed its stance on so-called self-indexed ETFs (ETFs which track an index managed in-house or by an affiliate).
Now, says the SEC, committing to publish an ETF’s holdings daily will be sufficient to get a self-indexing application passed. ETF issuers will no longer have to comply with a long list of restrictions aimed at preventing potential conflicts as a result of dealing with an affiliated index provider.
The new self-indexing rules bring such ETFs into line with active ETFs (ETFs which don’t track a benchmark), which also have to disclose portfolio holdings daily.
In the US, daily portfolio transparency is a legal requirement only for self-indexed and active ETFs. Those funds tracking third-party indices (which make up the lion’s share of the market) have to reveal their holdings only quarterly. In Europe the minimum requirement is for a fund’s holdings to be published in the semi-annual and annual report and accounts.
However, most ETFs, both in the US and Europe, go further than this and do provide daily holdings transparency. Here, for example, is Friday’s portfolio of iShares’ FTSE 100 ETF, with a full list of holdings and their weightings, taken from the company’s website.
There’s a notable exception to this widespread policy of daily disclosure. On both sides of the Atlantic, Vanguard shows its full portfolio holdings only with the minimum required frequency. As Vanguard has been the fastest-growing ETF provider in recent years, this policy doesn’t seem to have harmed it.
But ETF holdings are only part of the story. If you’re trying to work out how an ETF is meeting its stated objective, or whether the fund manager is taking unnecessary risks or even misstating his performance, you surely also need information about the index.
This was the essence of what S&P Dow Jones’s CEO, Alex Matturri, told IndexUniverse.eu last week when criticising the SEC’s decision.
“Relying only on the disclosure of the fund holdings defeats the objective of providing transparency, which is what ETFs are all about,” said Matturri. “You need some assurances about what you’re investing in, and portfolio holdings alone don’t give you that. You need the index methodology as well.”
Matturri added that if you allow a fund issuer to develop its own index, then to run a fund against it without offering any index disclosures, you’re showing a green light to conflicts of interest.
One commenter on a Bogleheads discussion on the topic of the SEC’s new self-indexing rules quipped that, by being permitted to track “secret” indices, fund managers have finally found a way to beat their benchmarks 100% of the time.
But when it comes to disclosures of information regarding ETFs’ underlying indices, things are even more complex.
US mutual fund regulations require a fund to invest at least 80% of its assets in securities suggested by the fund’s name, so if an ETF says it tracks an index its holdings do provide limited visibility into the underlying benchmark (note, however, the recent trend to remove the index’s name from that of the fund, which gets around this regulatory constraint).
But in Europe in particular, fund holdings alone often tell you nothing at all about the index being tracked. Synthetic (swap-based) ETFs commonly hold a so-called “substitute” basket that has nothing to do with the index.
As an example, the swap-based db x-trackers FTSE 100 ETF currently holds as collateral a variety of European equities, including a large number of Spanish and Italian issues, together with some German and Japanese corporate bonds.