If you invest in index ETFs, you might think of yourself as a buy-and-hold investor. But new research shows there might be more trading going on than you realize.
Roughly a quarter of the hundreds of ETFs and mutual funds studied changed the index that they were tracking since inception, says new research from Morningstar's Daniel Sotiroff. This is surprising, as many index investors assume they're locking into an index and riding it through ups and downs — not making active bets trying to time the market.
And it's not just smaller ETF providers that are making adjustments to their funds. The ETFs making the most changes include the titans in the industry like Invesco, iShares and ProShares. And nearly 60 funds changed their index more than once.
"Active decisions can still squeeze their way into index-tracking funds, though," said Sotiroff in the report. "One way is when an index fund changes its target index. Indeed, a decent subset of the index-tracking mutual funds and exchange traded funds available to U.S. investors have changed their target index at least once."
Why Do Funds Change Their Indexes?
There are many reasons why a fund might change its index. And the reason for the switch is important for investors to note.
Some of the funds upended their investment approaches — and so needed a different index. Nearly 25 funds changed their index to take a passive approach and give up on trying to pick individual stocks. An additional 13 did the opposite and switched to an active approach.
Most of the time, though, the new index is all about saving money for the fund provider. Some indexes cost less to license. And those lower costs can benefit shareholders, too, with potentially lower expense ratios. Switching an index, too, might benefit the fund if changes to the index's constituents are less frequent and reduce trading activity.
But sometimes the index changes are more radical. The Invesco S&P 500 GARP ETF switched to the S&P 500 Growth at a Reasonable Price Index from the Russell Top 200 Pure Growth Index in June 2019. They are entirely different indexes with different performances. The difference of returns between the two is more than 7% annually in the past five years, Morningstar found.
It's up to investors to keep a lookout for such big changes and decide if the fund is still for them, says Todd Rosenbluth, director of research at Vetta Fi.
"When an index makes a change it is always important for an ETF investor to take pause and make sure the change is for the best," Rosenbluth said.
Watch Out For 'Hail Mary' Changes
Bigger funds that made index changes are usually trying to leverage their size to get better licensing deals. But for smaller funds, with low asset bases, the changes might be efforts to simply survive, Sotiroff says.
These efforts, though, don't usually pan out for smaller funds. "If that's the intention, the evidence suggests the tactic hasn't worked out well," Sotiroff said. "Cumulative fund flows over the 12 months after target-index changes indicate that many struggled to attract new investors."
So if you own funds, make sure you periodically review regulatory filings for any index changes, Rosenbluth says. "A fund will disclose the new and old indexes to give investors clues," he said. "If the fund sounds different, it is different. An ETF is largely a basket of stocks or bonds, and what's inside matters a lot."
Switching It Up
Number of index changes since fund inception
| Fund family | Index changes | Assets (in billions) |
|---|---|---|
| Invesco | 60 | $827 |
| iShares | 49 | 2,950 |
| ProShares | 39 | 72.1 |
| First Trust | 35 | 177.3 |
| Vanguard | 30 | 8,280 |
| Charles Schwab | 19 | 558.7 |
| State Street | 18 | 1,399.1 |
| WisdomTree | 15 | 80.99 |
| Alpha Architect | 8 | 4.92 |
| VanEck | 7 | 85.6 |
