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Posted by on Feb 26, 2009 in AdvisorShares, Investment Perspective

Making Changes To Your Own Index

There is a story in Index Universe regarding WisdomTree’s SEC filing regarding the changes to two dividend income ETFs that will no longer include financial stocks.  The interesting story behind this is based on WisdomTree’s innovative model of index-based ETFs that follow their own indexes.  They are still the only firm to offer index-based ETFs on their own indexes.  So for the ETFs to make a change, first the index must make a change. 

This a great feature to have control over your own indexes, so that you can adjust them to prevailing conditions in the market.  I was reading a story recently how the S&P 500 changed its methodology last year to allow the minimum market cap for stocks included in the S&P 500 to move from $5 billion to $3 billion.  Apparently now, so many stocks in the S&P 500 have moved below a $3 billion dollar market cap, S&P has the “discretion” to look past that and keep the lower cap stocks in the index (which could lead to an entirely different discussion on the opinion that the S&P 500 is actively selected stock basket called an index).    Back to the point, WisdomTree’s ability to change the construction of their indexes is an innovative approach to index ETFs, and a feature that financial advisors must ensure they are properly educated on when selecting ETFs to use in their investment strategy.

I did notice in the story that the indexes have not been fully calculated yet, as it was unclear what impact the change would have on the yield of the ETFs.  It would also be interesting to see if there are any issues of the tracking of the ETFs relative to their indexes.  Will the indexes be recalculated as if they never held financials, or will there be an asterisk to indicate at one point the indexes did hold financials?? 

My guess is they will not historically recalculate the indexes, if they did, removing financials would improve the (historic) performance of the indexes, as we now know financial stocks have not been doing very well.  Since the ETFs have been holding financial stocks, and if the index is changed historically, it would probably automatically have an underperforming historic performance to the newly calculated indexes.  It will be interesting to see the results of the change.