Why Do ETFs Change Indexes?

In late 2017, ETF Managers Group made headlines when it swapped the benchmark for its Tierra XP Latin American Real Estate ETF (LARE) to the marijuana-focused Prime Alternative Harvest Index. The resultant fund, the ETFMG Alternative Harvest ETF (MJ), became the first pure-play marijuana ETF to hit the market (read: “When An ETF Changes Its Exposure”).

At the time, the move shocked many industry participants and observers, but the index switch itself was and remains perfectly legal. That’s because, for the vast majority of ETFs, there’s no requirement that the index an ETF starts with must remain its benchmark forever.

By and large, that’s a good thing. It gives ETF issuers the flexibility to swap indexes as needed, switching to a cheaper index provider or to a benchmark that tracks the intended investment objective more closely.

However, it also allows issuers to cannibalize their own ETFs, a practice that, while eliminating the expense and regulatory hassle of launching a brand new ETF, can also radically change a fund’s investment objective without any input from the fund’s current investors.

Why Issuers Change Indexes

Changing an ETF’s benchmark index isn’t all that uncommon an occurrence. Since the start of the year, 27 ETFs have changed their underlying indexes, while there have been hundreds of additional instances since 2003.

Historically, when this happens, ETF issuers have tried to maintain some consistency between their old and new benchmarks. Though index providers may change, or the breadth of the securities universe may be tweaked, a small cap ETF generally remains a small cap ETF, a tech fund a tech fund, and so on.

Other times, issuers change an ETF’s index specifically because a significant exposure change is coming, and they want to smooth the ride for investors planning to stay in the fund. For example, in advance of the revisions to the Global Industry Classification Standard (GICS) that went effective last September, Vanguard switched several of its ETFs to a series of transitionary indexes that eventually resulted in new GICS-compliant benchmarks (read: “Changes Ahead For 24 Sector ETFs”).

Sometimes, however, the change of a benchmark comes with little warning, and results in a dramatic change to the ETF, transforming large cap ETFs to small cap ones, or switching the focus from one single-country market to another.

For example, in 2017, Deutsche Bank switched the index of its Xtrackers MSCI Italy Hedged Equity ETF (DBIT), turning the fund into a single-country Germany ETF, the Xtrackers Germany Equity ETF (GRMY). (GRMY ceased trading earlier this year.)

Another radical change occurred back in 2013, when Exchange Traded Concepts switched the index of its existing Canadian oil sands ETF, transforming it into an income-focused fund of funds, the YieldShares High Income ETF (YYY).

The trend continues to this day. In the table below, we’ve listed some of the more striking index switches of 2019:

Source: ETF.com; data as of July 7, 2019