There’s no denying the attraction investors currently have to ETFs. Market growth continues to surge (up to nearly $10 billion in late 2013) and as new products are launched, growth shows few signs of slowing.
Equal Weight Indices
Equal weight indices are new to Australian investment markets (whereas global investment markets saw equal‐weighted ETFs launched in the US in 2003). Australia received its first taste when Market Vectors launched the Market Vectors Australian Equal Weight ETF in March 2014.
As its name suggests, an equal‐weighted index means that every stock in the index has the same weight, regardless of the company’s size. Therefore, even BHP will have the same weight as the smallest company in the equal‐weighted index.
In contrast, most indices (such as the S&P/ASX200 Index) are market cap‐weighted. This means that companies with the largest market cap will have the highest weight in the index. By way of example, the largest company in the S&P/ASX200 Index is BHP, with a market cap of over $200 billion and a weight of approximately 9 per cent of the total index.
Some key distinctions in equal‐weighted ETFs that investors should understand.
An equal‐weighted index will have greater exposure to smaller cap stocks than the market‐cap equivalent. As a consequence, volatility is expected to be higher for equal‐weighted indices versus market‐cap indices, due to the higher skew to mid and small cap stocks.
The equal‐weighted index also has different sector exposures compared to the S&P/ASX200 Index. For example, financial stocks make up 38% of the S&P/ASX200 Index, while they are a far more modest 19% of the Market Vectors equal‐weighted ETF.
Turnover and associated trading costs are likely to be higher in equal‐weighted indices as the index is rebalanced quarterly – as shares of outperforming stocks are sold down and shares of underperformers are purchased. In contrast, market‐cap indices do not need to be periodically adjusted.
Currency Hedged ETFs
Currency hedged managed funds are nothing new, but until recently there was only one ETF issuer that provided currency hedged ETFs listed on the ASX.
State Street Global Advisors (SSgA) has now joined Beta Shares in providing a currency hedged ETF. The SPDR S&P World ex-Australian (Hedged) Fund ETF, provides investors with a global equities exposure (ex-Australia) hedged beck to AUD. In other words, investors receive the performance of the index or the benchmark, without any ‘noise’ created by the movements in the AUD versus the currencies the ETF assets is denominated in.
While hedged ETFs should closely track the underlying index, investors should be aware that the tracking error of a hedged ETF is likely to be somewhat higher than that of non‐currency hedged ETFs. This is due to some assumptions made in the construction of the hedged benchmark.
When considering the application of these newer ETFs, investors should be aware that, in the same way that different investment styles (such as growth or value) outperform during different market cycles, market cap‐weighted and equal‐weighted indices are likely to be better suited to certain market cycles.
Similarly, currency hedged ETFs will benefit investors at times when the AUD is rising but will not do as well as non‐currency hedged ETFs when the AUD depreciates.
Amanda Gillespie is the chief executive of Lonsec Fiscal Holdings.
