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Oct 24, 2018

Inside the changing world of ETFs

Highlights from the recent IR Magazine Think Tank – Canada

One of the biggest talking points from the recent IR Magazine Think Tank – Canada was how to tell the difference between different exchange-traded funds (ETFs), what IR teams can do to influence ETF portfolio managers, and what else IR teams need to know.

The audience of more than 60 people heard the answers to these questions and much more during the interactive ETF session. In this article we provide the highlights.

Understanding how ETFs are created

Steven Hawkins, president and CEO of Horizons ETFs, started the ETF session by explaining how index providers launch these funds. Typically, he said, an ETF provider will approach an index provider with a theme, or thesis, that it wants to be able to sell because it believes there will be investment interest in it.  

‘There’s an index now for everything,’ Hawkins said. ‘There are more indexes in the world than there are listed equities in the world. Indices are very adaptable to whatever is going on in the marketplace and there are new and creative ideas every single day.’

Hawkins provided several examples of recently formed or forthcoming ETFs, including:

  • iBuy, which tracks the spending behavior of women
  • Make America Great Again, which indexes companies that are likely to benefit from US President Donald Trump’s America-first policies
  • Marijuana ETF, one of Hawkins’ firm’s products, which gives investors access to marijuana life sciences companies
  • Alcohol, tobacco and firearm-free ETFs.

Understanding the original thesis behind the ETF is key to understanding why your stock is, or isn’t, included in it, Hawkins explained.

Active versus passive ETFs

ETFs are often thought of as vehicles for passive investors, but one speaker at the event explained that in Canada, 45 percent of ETFs are actively managed. Understanding the difference is key, he added, to understand the behavior of the ETF in relation to your stock.

‘You hear this nomenclature about active, passive, mutual funds and ETFs. But I think that’s just people trying to put different products in boxes,’ said Manash Goswami, senior vice president and head of ETF portfolio management at First Asset. He is responsible for both active and passive ETFs and explained how the difference affects him on a regular basis.

With passive ETFs, Goswami explained, he is beholden to the thesis behind the creation of the ETF, which is determined by the index provider. Therefore, if a company is going to be added to an index, ‘I can’t say we’re not going to add it because there isn’t any leeway when there’s a clear prospectus in place,’ he said. But on the active side, he can do that, which he acknowledged is a ‘really big distinction’.

Understanding the difference between active and passive ETFs can help IR teams understand why and when there is movement in their stock – notably because the passive ETFs are much more beholden to rebalances.

Understanding ETF rebalances

Rebalances occur several times a year within an ETF to ensure the companies included are still aligned with the thesis that underpins the product. ‘If you’re being added, deleted, up-weighted or down-weighted, those are all pretty big things to know,’ Goswami said. ‘But no-one’s going to tell you.’

There are, however, resources available to help, both panelists agreed, including research companies that write about index rebalancing. In addition, a representative for the TMX Group, which hosted the event, said it keeps a record of ETF rebalancing dates and can provide them to issuers. Several audience members said they currently actively track ETF rebalancing dates by adding them to their calendars to better understand their stock performance.

Goswami said IROs can likely predict whether their stock is going to be included or excluded from an ETF based on what their company is doing. For instance, if the company has recently undertaken share buybacks, that may qualify it for an ETF with that investment thesis. Understanding this and knowing when your stock may be likely to drop out of an ETF can present IR teams with an opportunity to proactively approach other investors ahead of a rebalance, Goswami said. ‘If you know there’s a rebalance coming you can go to your other investors and say there may be liquidity coming,’ he said.

Advice for IR

Other than knowing ETF rebalancing dates and understanding how business decisions can affect a company’s inclusion in an ETF, Hawkins said the best advice for IR teams is to know their company inside out.

‘Traditional sectors are constantly changing and there are new types of companies coming to the market all the time,’ he said. ‘That means we have new thematic ETFs coming to the market. To understand whether your company qualifies for a thematic ETF, we need to know what it is you actually do. Having a very simple description of what your company does, where you’re doing your business, how you’re doing that business and who your clients are goes a long way for us in dealing with index providers.’

Ben Ashwell

Ben Ashwell was the editor at IR Magazine and Corporate Secretary , covering investor relations, governance, risk and compliance. Prior to this, he was the founder and editor of Executive Talent , the global quarterly magazine from the Association of...