Which is more important: tracking a benchmark or getting exposure to the equities that benchmark represents?
It's more complicated than one might think. In the recent past, a major Canadian ETF supplier—BMO—shifted from one benchmark for emerging markets to another. The explanation: retail investors typically benchmark emerging market exposure against MSCI indexes in their investment policy statements.
By contrast, another ETF supplier changed its benchmark from MSCI to FTSE. That would be Vanguard. Its MSCI-based emerging markets ETF has been a hot seller for a number of years. When it changed benchmarks, there were expectations of outflows. And, according to the Financial Times, there were significant outflows from VWO (Vanguard's product) to EEM (the iShares equivalent). Call it IPS bias: you set up a performance baseline for clients using recognized benchmarks and then plug assets into ETFs that follow them.
Except the indexes are not stable either. According to Index Universe, MSCI has just kicked Greece out of the developed market index—only two stocks qualified anyway—and into the emerging market index. The MSCI emerging market index will now also include Qatar and the United Arab Emirates, which have been promoted from frontier market status.
This might sound like simple housekeeping. But what does South Korea have in common with Greece or Qatar? South Korea is an emerging market, according to MSCI, but a developed one, according to FTSE.
Large-cap indexes, weighted by company value, are following the same market with the same methodology. Smart beta indexes—fundamental, equal-weight and low-volatility strategies—are going to have different weights and constituents. And so too is a newer set of indexes devised by Morningstar's CPMS division, which First Asset has licensed for momentum, value and dividend ETFs.
That may require an adjustment in the ISP. Otherwise the tracking gauge may read half empty when the tank is three-quarters full.