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2:46 pm
July 15, 2009
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Someone
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Hi,
I am thinking of moving some money back into the market from my "high" interest savings account. I'm leaning towards using ETFs over Mutual Funds with their lower overall cost. I am wondering how index ETFs work when a company is removed/added in the index ie TSX. Doesn't this lead to a run on the price of Company X with the increased demand/supply?
Thanks
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8:10 am
July 16, 2009
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Craig
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Depends on how broad the ETF is. If you buy into an ETF that tracks a large index (say, the TSX composite), you won't even see a blip. Keep in mind that ETFs are, for the most part, "supposed" to be long-term investments (even though you can buy/sell options on them, short them, etc…) so one company isn't going to make a difference in the long run even with a narrow ETF. As for the Mutual Fund vs. ETF debate, if you look at historical returns, something like 60% of all funds failed to meet their benchmarks, so if you had invested in ETFs over the same period, you would have had a 60% chance of beating out the funds. The thing is though, there may be a massive stock rally just around the corner, and investors might make better gains by investing in equity funds rather than ETFs, at least in the near-term. At the end of the day, you need to make decisions based on how much risk you're willing to take on.
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11:38 am
July 16, 2009
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Someone
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Thanks for the reply.
I don't think I explained my question properly. My apologies. I'll try again.
For this argument I'm going to use:
iShare LargeCap 60 (XIU): Asset Value ~ $9B
http://ca.ishares.com/product_info/fund_holdings.do?ticker=XIU
The last company on XIU's list of holdings is MDS Inc (MDS) currently trading at $6.40 and a weight of 0.07% of XIU. MDS Market Capital = $768.88M.
If I take 0.07% of $9B, that gives me $6.3M or ~1M shares of MDS. Except for a couple of outliers the average volume of trading MDS seems to be 100K – 500K per day.
Hypothetically, if MDS was to be removed from the LargeCap 60 index, XIU would be forced to sell all it's shares in MDS and buy it's replacement correct? Since XIU is a passively managed investment, the manager does whatever the market tells him to do. In this case the manager would be required to sell MDS asap. If 1M shares of MDS suddenly became for sale, wouldn't that drive down it's price and flood the market. In contrast, wouldn't the new company to be added to XIU receive a huge increase in demand and prices sky rocket?
I appreciate all the help. Please correct me if I'm wrong or misunderstand an ETF. I want to better understand them before I invest in them and this one point has always confused me.
Thanks.
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12:42 am
July 21, 2009
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Someone
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anyone have any input?
Much appreciated.
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8:57 am
July 21, 2009
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Scone
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Read the fund's prospectus. That will tell you how the fund responds to situations like the one you described.
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11:13 am
July 21, 2009
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Choppy McSlice
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This may be a shot in the dark, but don't most Index ETFs say that they merely aim to replicate the performance of a market index? To me, that would imply that would buy shares of close to all of the companies in the index in proportion to their market caps, but not necessarily every last one. For example, the TSX index funds might not all even have MDS in their holdings. And even if MDS was to be removed from the index, the ones that have it might still hold on to it, or even just sell some of it. I'm sure that the fund managers are aware of the hypothetical situation you described above, and try to avoid that sort of behavior, in order to avoid selling into a glutted market and losing money.
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