It is important to understanding what an exchange-traded fund (ETF) invests in, since many ETFs track the same index. Some ETFs track a sub-index (an index within an index). You might accidentally invest in the same group of companies even though you have a number of different ETFs.
Minimum disclosure documents (MDDs)* are designed to help us understand what’s inside a fund. Since their publication is a legal requirement under the Collective Investment Schemes Control Act, all exchange-traded fund (ETF) issuers publish one for each fund at least once a quarter. If you’re interested in the legal requirements, you can download them below.
Where do I find an MDD?
All ETF issuers have to publish these documents and you can get them directly from the issuer’s website. Those would be companies like Satrix, Sygnia, 1nvest and Cloud Atlas, who make the ETFs.
However, etfSA publishes the latest MDDs here. We like this resource better since all the documents are in one place, making it much easier to compare different ETFs.
When you first look at an MDD, it might seem like gibberish. This week we’ll help you understand the objective. Next week we’ll delve into the fund information and the week after, the Top 10 holdings and sector exposure.
Each fact sheet starts with the objective. In essence, this deals with how the underlying index is put together – the index methodology, which we explain in detail in this post. These objectives can be littered with jargon and is very likely to send you running for the hills. Here are some of the words you should look out for and their meaning:
Each ETF buys the companies that are included in an index. An index is a tool we use to measure what the share prices of a group of companies do over a period of time. Indices (that means more than one index and is pronounced in-duh-seas) are made by specialist companies like S&P Dow Jones or MSCI. The ETF issuer buys the right to use the index from these companies and then buys all the companies in an index to put into a fund. Look out for the words, “to track, as closely as possible” in the MDD. That means you’re about to find out what index the ETF issuer uses.
This term refers to how much space a company can take up in the ETF. When we get to the Top 10 constituents, you’ll see this weighting in action.
Related to weighting, it means bigger companies take up more space than smaller companies.
This can mean the same as weighted, but is normally used in smart-beta ETFs. To be included, companies have to meet certain conditions relating to their size or how risky they are or how their share price behaves.
This is the maximum amount of space a company is allowed to take up in an ETF. Most of the time, this term will apply to smart-beta ETFs.
Indices clean themselves. Companies that no longer fit the conditions of the index are kicked out and new companies that qualify are added in. An ETF buys all of these companies and packages them in a fund. When the index kicks a company out, the ETF has to kick it out too. When a new company is included in the index, the ETF has to go buy shares in that new company. Adding and removing companies from an ETF comes at a cost to the investor, so the fewer times the ETF is rebalanced in a year, the cheaper the ETF will be. Typically ETFs rebalance every quarter.
This just means the price movement of the ETF will reflect what the share prices of the companies it is invested in do. This makes sense, because an ETF is just a tool we use to invest in different companies. Without the companies inside, it’s just an empty husk called a fund.
Since an ETF invests in many shares of many different companies, they can lend those shares to other people while you’re not using them. The ETF issuer makes a little money from this activity, making your ETF cheaper. Since the ETF issuer is the holder of the share on your behalf, should anything go wrong in this activity it has to be absorbed by the ETF issuer. Your shares are safe.
*Minimum disclosure documents are sometimes called “fact sheets”.
At Just One Lap, we are big fans of passive investment using ETFs. In this weekly blog, we discuss ETFs on the local market and the factors you need to consider when choosing an ETF. If you have wondered how one ETF differs from another, this is where you can find out. We explain which index each ETF tracks, what type of portfolio could benefit from holding each ETF, and how the costs will affect your bottom line.