Invest with purpose - in purpose-built ETFs
Purpose drives human behaviour. Ask investors why they invest and you will get a range of reasons: to save for a deposit on a house, to fund one’s retirement or to simply get richer. Whatever their motivation, investors have an outcome in mind.
Purpose drives human behaviours. Ask investors why they invest and you will get a range of different reasons: saving for a deposit for a house, funding a lifestyle in retirement or simply getting richer. Whatever it is, investors have an outcome in mind. So wouldn’t you prefer an investment that suits your purpose? For Exchange Traded Funds (ETFs) you want an ETF where the underlying index has been built with the investor in mind.
Traditional vs purpose-built indexes
Not all indexes are the same. Different indexes have different purposes. Before the phenomenal growth of ETFs, financial market indexes were and continue to be used as a measure of the performance of a particular market or sector. They are used in economic planning, as a simple tool for the media and as benchmarks to judge the performance of individual investments. The most well-known indexes are the country indexes which include the likes of Australia’s S&P/ASX 200, the S&P 500 in the U.S, UK’s FTSE 100, Japan’s Nikkei 225 and in Europe, the Dow Jones Euro Stoxx 50.
None of these indexes were designed specifically to be investable. They do their job well but their job was not designed to service investors in ETFs. They were not designed to be ‘investable’, they do not apply any liquidity tests, and they do not approach diversification in a considered way, other than just looking at the company’s market capitalisation. This is where Market Vectors indexes are different.
The table below compares how traditional indexes compare to the Market Vectors Australia Indexes:
|Market Vectors Indexes
|Extensive liquidity screens are applied to make sure that investors are not exposed to illiquid stocks
|Concentration and Diversification
|Weightings are only based on market capitalisation which may have a large cap bias
|Weightings are based on market capitalisation but are capped to reduce concentration risk and improve diversification
|Industry classification systems such as GICS, are designed to support the index’s role as a simple economic indicator. Each company can only be in one sector.
|Theme-based classifications purpose-built from an investor’s point of view that include companies outside the narrowly-defined industry where the company generates at least 50% of their revenue from the target sector
How does this work in practise?
Let’s answer the question by taking a look at the purpose built features included in the Market Vectors Australia Indexes which are used by Market Vectors ETFs:
- Liquidity: The Market Vectors Australia Junior Energy and Mining Index does not include Roc Oil as it is not sufficiently liquid. Roc Oil is however included in traditional small cap indexes. Liquidity of the underlying securities is very important for ETFs as it affects the investment manager’s ability to track the index as well as the spreads offered by market makers. This is particularly important when an ETF is new. Further, lack of liquidity can depress a company’s stock price. A portfolio of illiquid stocks can therefore lose some of the value created by the sector.
- Concentration and Diversification: The exposure to Westfield Group in the Market Vectors Australia A-REIT Index is capped at 10% whereas equivalent traditional indexes include exposure of around 25%. The Market Vectors Index removes the Westfield Group concentration and provides investors with a more diversified exposure to the Australian property sector.
- Classification: The Market Vectors Australia Energy and Mining Index includes securities like AGL, Aurizon Holdings, Monadelphous Group and Orica Group which all generate more than 50% of their revenue from the Mining and Energy sector. These securities are not included in traditional Mining and Energy indexes because the classification systems include them in other categories. The Market Vectors index provides investors access to the full spectrum of securities whose revenue is dependent on the Mining and Energy sector
So, what do you need to do to identify whether an index is ‘purpose-built’ or not?
Look under the bonnet of the ETFs and ask yourself these key questions:
- What securities am I getting exposure to?
- Are they liquid?
- Am I getting true diversification or do a handful of securities dominate the index?
- Does the purpose of the index match the purpose of my investment?