Do you know what’s hid­ing in your ex­change-traded funds?

Miami Herald - - FRONT PAGE -

range of in­vest­ment themes, slic­ing and dic­ing the mar­ket by al­most any cat­e­gory imag­in­able — cap­i­tal­iza­tion, in­dus­try, value, coun­try and more. If you re­ally want to bore in on a spe­cific sec­tor, ETFs can let you do that — at least, that’s the idea.

Take a look at the iShares MSCI Spain Capped ETF, which is meant to give in­vestors ac­cess to large and mid­sized com­pa­nies in a sin­gle coun­try, ac­cord­ing to its fund man­ager. But while the fund does use stocks listed in Spain, the rev­enues of those com­pa­nies largely come from out­side the coun­try. Ac­cord­ing to as­set man­ager Hori­zon Ki­net­ics, the top 10 com­pa­nies within this ETF, which ac­count for more than two-thirds of its to­tal as­sets, de­rived 53 per­cent of their sales from out­side Spain as of Dec. 31, 2016.

The iShares MSCI United King­dom ETF has a sim­i­lar is­sue. The fund means to be U.K.-fo­cused, but it’s stuffed with global multi­na­tion­als, which de­rived 64 per­cent of their rev­enue from out­side the U.K. in 2016, ac­cord­ing to Hori­zon Ki­net­ics.

These aren’t iso­lated events; mis­matches can oc­cur in many funds. Small­com­pany ETFs might have lit­tle ex­po­sure to truly small com­pa­nies, pre­fer­ring to shade into more liq­uid mid­size firms. And as Hori­zon notes, sup­pos­edly val­uethemed ETFs may de­liver less growth and yet be more costly than the over­all S&P 500, so hardly a value.

If you want to fig­ure out what’s re­ally in an ETF, you’ll have to dig be­yond its name.

The rise in ETF in­vest­ing has cre­ated a mar­ket where fund man­agers are awash in cash that must be placed in themed investments. Over the past decade, more than $1 tril­lion has moved from ac­tively man­aged stock mu­tual funds to pas­sively man­aged stock in­dex funds and ETFs.

The more money an ETF has, the more it will be forced to chase larger com­pa­nies, since these stocks can more eas­ily ab­sorb the dol­lars flow­ing in. But there’s a lim­ited se­lec­tion of large, liq­uid com­pa­nies. And, re­turn­ing to the ear­lier ex­am­ples, these com­pa­nies tend to op­er­ate glob­ally, so only small per­cent­ages of their rev­enue come from any one coun­try. It ends up be­ing hard for an ETF to get “pure” ex­po­sure to, say, Spain or the U.K. The first der­stand­ing step is un­that a niche ETF might not be quite as fo­cused as its name sug­gests.

Then you can find out much of what a fund does own, be­cause each ETF de­tails its top 10 stakes, in­clud­ing names and po­si­tion sizes.

But you’ll have to dig deeper — into the EDGAR data­base on the Se­cu­ri­ties and Ex­change Com­mis­sion web­site, for ex­am­ple — if you want to de­ter­mine how much busi­ness a com­pany does in a cer­tain niche.

That de­feats much of the pur­pose of this kind of ETF: speed and sim­plic­ity.

The in­for­ma­tion the ETF pro­vides can also help in- vestors who as­sume that a themed fund will help them di­ver­sify their port­fo­lio. For ex­am­ple, in the Spain fund, the top po­si­tion, Banco San­tander, makes up more than 18 per­cent of the fund’s as­sets — so if you al­ready own that stock, or an­other fund that con­tains that stock, your port­fo­lio’s di­ver­sity will ac­tu­ally suf­fer.

With so many funds in­vest­ing in the same large com­pa­nies, you might end up with a big­ger al­lo­ca­tion to one com­pany than you want. So if you’re look­ing to ETFs for di­ver­si­fi­ca­tion — or for a pre­cisely tar­geted in­vest­ment — read the fine print first.

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