Advisors, beware—index fund asset managers can change their target indexes without you noticing. A new study from Morningstar, “The Transformation of Index Funds: More Than Meets the Face,” found that about a quarter of the index funds it examined switched target indexes at least once since their inception. Depending on how significant the change is compared to the original indices the funds tracked, such moves can affect the risk/return profiles investors will see.
“We know this happens more often than the general public probably realizes, but I was a little surprised by the scale,” said Daniel Sotiroff, managing director, senior research analyst, passive strategies, with Morningstar and author of the report.
The Morningstar study examined approximately 1,200 SEC filings and websites of index-tracking funds to identify any changes in investment strategies. He concluded that 310 funds switched target indexes at least once, and 57 switched indexes several times.
Asset managers with $500 million in AUM or more, including BlackRock, Invesco and Vanguard, tended to change the target indexes in their funds more often than their smaller peers. For example, Invesco was responsible for 60 of the index changes included in the study, iShares for 49 and Vanguard for 30. However, most of the largest asset manager changes tended to be small, rarely resulting in significant revisions to risk/reward of funds. formulas. Morningstar considers minor changes that include switching to another target index in exchange for lower licensing fees or trying to reduce trading costs by spreading trading activity over several days or quarters.
Smaller asset managers, on the other hand, were more likely to make drastic changes to their index-tracking strategies, including switching asset classes and investment styles or switching from large-cap to small-cap. Sotiroff mentioned an ETF that started out tracking Latin American real estate and then switched to tracking cannabis. “Those are the big, wholesale changes that investors need to watch out for, because those are the ones where you're not going to get what you originally signed up for,” he noted.
This trend is driven by the pressure smaller funds may face to grow their inflows quickly if they are to survive. To increase their assets under management, they may abandon a strategy that isn't attracting attention for one that may seem more fashionable, Sotiroff noted.
Morningstar data showed that most funds that change their target indexes tend to do so within the first few years after inception, with more than 80 of the funds tracked making these moves in years four to six of existence. theirs. About 70 other funds made such changes two to four years after inception. Changes later in the life of the funds tended to be rare.
However, Morningstar found that making drastic changes to their index-tracking strategies often doesn't help smaller funds attract new inflows. Approximately 43% of funds that changed the indexes they tracked experienced outflows after doing so. An additional 35% of funds saw inflows totaling $100 million or less. According to Morningstar, funds that saw $1 billion or more inflows in the 12 months after adopting the new target indexes tended to be larger funds such as those managed by Vanguard and BlackRock, which were likely already popular with investors. .
So how can advisers ensure they don't unknowingly continue to invest in a fund that may have completely overhauled its risk/reward profile? Sotiroff encourages them to at least briefly review any notices they may receive about new changes in the funds they invest in, and to periodically check through the SEC's website or the fund websites that the indexes they're following have remained the same.
“My impression is (councillors) probably don't know that this happens as often as you would expect. To the extent that they're using the smaller funds that are probably going to be more sensitive to these changes, I think it's important that they understand that it's a risk,” he said.