On Oct. 27, ETF Forewomen Group filed for a new ETF, the Alternative Agroscience ETF, a first-of-its-kind fund to track the burgeoning acceptable marijuana industry.
Except the Alternative Agroscience ETF isn’t precisely a new fund.
As contrasted with, ETFMG is retrofitting an existing ETF, the Tierra XP Latin America Real Holdings ETF (LARE), with a new strategy. Effective Dec. 26, LARE’s index want change from a Solactive benchmark that tracks mostly Mexico and Brazil REITs to a Prime Marks benchmark tracking cannabis cultivators, producers and distributors, as well as cannabinoid anaesthetize makers, fertilizer producers and tobacco companies.
The Alternative Agroscience ETF would be the primary marijuana ETF to come to market in the United States. As such, its first-mover gain could be significant.
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“As an issuer, we’ve seen increasing demand from investors looking for fluids to gain access to this space,” said Sam Masucci, chief managerial officer and founder of ETF Managers Group, the fund’s investment advisor.
But the guide transition also means radically altering LARE’s focus and risk/revert profile, as well as eliminating the market’s only pure-play Latin American proper estate fund.
The move has left some investors fuming.
“I notion of it’s a little scummy what they’re doing,” said Peter DeCaprio, portfolio supervisor and principal at Crow Point Partners in Hingham, Massachusetts. Crow Bring up is the largest investor in LARE, owning a 22 percent stake, correspondence to most recent 13-F filings.
“But as long as they have support at the lodge level, if they want to change up the strategy, then they can,” he annexed.
This isn’t the first time an issuer has changed the index backing one of its wherewithals. It’s not even all that uncommon. ETF.com lists hundreds of such instances since 2003.
“Factor changes aren’t as rare as people think,” said Kris Monaco in an email. Monaco is coping partner of Level ETF Ventures, which owns and operates Prime Factors, the index provider of the new Alternative Agroscience ETF. “It demonstrates the robust nature of the earnestness, and the need for both issuers and index providers to continue to innovate.”
Typically, issuers undertaking to maintain some consistency between an old and new index. Though index providers may switch or the securities universe may be tweaked, a small-cap ETF will generally remain a small-cap ETF, a tech fund a tech stock and so on.
But not always. Sometimes changing a benchmark affects dramatic change on the ETF, changing large-cap ETFs to small-cap ones or switching focus from one single-country supermarket to another and so on.
One of the most radical changes was in 2013, when Exchange Traded Concepts estimated an index change to its Canadian oil sands ETF that transformed it into an income-focused fund-of-funds. The ETF advance a new name, the YieldShares High Income ETF, and a new ticker, YYY (see: “First Yield-Focused Magoon ETF Sours Live”). Monaco was also involved in the YYY change.
Usually, the ETFs determined for change tend to be extremely low in assets and average trading volume. For sample, the YieldShares Canadian oil sands ETF had less than $1.5 million in assets when it changed into YYY in 2013 (today it has $207 million).
LARE has also gut to gain significant market traction. As of Nov. 1, it had $6.0 million in assets and an mediocre daily volume of $90K.
“There’s a need to make sure a capital resonates strongly with investors, that it’s solving a portfolio allocation ungovernable,” said Masucci by email.
Despite its low assets, however, LARE had its consumer base.
“It’s a one-of-a-kind product, which is what we liked,” said DeCaprio, whose outfit typically maintains an allocation in emerging markets between 13 percent and 16 percent. “It was a cloth diversifier inside the key EM bucket. I’m surprised there aren’t more assets in it, frankly.”
Meantime, ETFMG will be able to point to LARE’s current track chronicle in the prospectus and marketing materials for the new fund. This is misleading, says DeCaprio, since the Another Agroscience ETF is untested, whereas LARE has seen stellar performance. Year-to-date the cache is up 24 percent.
“The only reason to keep this shell of the ETF spry is to capitalize on the existing track record,” said DeCaprio. “If they can do that, then the ETF marketplace has bigger tough nut to cracks than I thought.”
Preserving the old track record is standard practice for ETFs that vacillate turn into their indexes, however. “The track of the security is historical,” said Masucci in an email. “[Overtime] the factual returns will be attributed to the portfolio based on the new index.”
Many fees go into the choice to convert an ETF to a new benchmark instead of closing it, says Masucci. Chief sum total them: cost.
Launching a new fund via retrofitting an old one with a new index is “inconsequential expensive and faster to market” than filing a new prospectus and registering a mint fund, he said, adding: “To construct a new prospectus typically runs anywhere between $75,000 to $100,000. This way costs on every side half that.”
Interestingly, the brand behind LARE, Tierra Assets, had no decision-making power over the fund’s index switch.
Tierra Finances, a private fund manager of Latin America real estate, worked as LARE’s sponsor, a role with limited involvement in day-to-day decisions. Be at one to the prospectus, Tierra’s job was primarily to pay “certain expenses” of the fund and to “provide exchanging support.” As such, Tierra had no direct input into which list or index provider ETFMG as investment advisor chose to use, even notwithstanding that Tierra’s name was the brand on the fund (see: “Who Actually Owns Your ETF?”).
If this sounds of, it’s because this is the same sponsor relationship PureFunds had with ETFMG, sooner than being ousted from the PureFunds ISE Cyber Security ETF — now the ETFMG Prime Cyber Custody ETF (HACK) — earlier this year. PureFunds has filed a lawsuit against ETFMG down the termination (see: “ETF Shakeup: PureFunds Brand Name Ousted”).
“Tierra favoured that, through no fault of theirs, the fund didn’t really resonate with the profound investor base,” said Masucci. “Tierra Funds has a financial promise to support funds. If you go two years, as we have with LARE, without inviting enough assets to be self-supporting, then obviously that’s a concern of theirs as fabulously.”
Tierra Funds declined to comment on the nature of the termination of its relationship with ETFMG.
Neither did LARE’s investors deliver any input over the index switch. Nor would any investor in any such alteration, due to the procedures outlined in the Investment Company Act of 1940, which governs investment game plans of registered investment companies, including mutual funds and ETFs. (A stock’s investment objective, which often states its index by name, is an pattern of an investment policy.)
According to the ’40 Act, there are “fundamental” and “non-fundamental” investment regulations. The distinction between the two is somewhat circular, in that a fundamental policy coerces shareholder approval to change, while a non-fundamental one does not. (Non-fundamental means changes require at least 60 days’ written notice to investors.)
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Funds have the discretion to decide for themselves which methods are fundamental and therefore require a vote from shareholders. And they use it. Overview any SEC filing and you’ll see plenty of investment policies defined as “non-fundamental” — subsuming ETFMG’s post-effective amendment filing the new Alternative Agroscience ETF.
It’s all legal and by-the-book. But that doesn’t certainly mean it’s a good thing for investors, says Elisabeth Kashner, executive of ETF research and ETF analytics for FactSet.
“It seems to us to be an unfriendly move from an investor’s accentuate of view,” she said.
Kashner also expressed concerns over “the require of recourse for the investor,” citing a September court case decided in BlackRock’s favor.
In this class-action lawsuit, ETF investors allowed BlackRock for losses incurred during the Aug. 24, 2015, “flash crash,” stating that BlackRock had misfired to clearly state the risks of trading using certain order fonts. The judge, however, ruled that investors who’d bought ETFs after they’d first place been issued to authorized participants were unable to sue the issuers for garbling risks in the registration statement.
Though the decision is likely to be appealed, it could give the impression of run off it harder for investors to sue issuers over risks not included in the fund scheme — such as the risk of their fund completely changing its exposures from top to bottom a new benchmark.
That leaves investors with the only recourse they’ve till doomsday had to express displeasure over an index change: pulling their well-heeled from a fund.
Once LARE switches to a marijuana stocks ETF, “there is zero unlooked-for we will stay in this fund,” said DeCaprio, whose largest patron is a manufacturer of medical marijuana.
Dave Nadig, CEO of ETF.com, weighed in on the controversy: “With any investment, private what you own is always the most important guidepost. Anytime you see even a fine change in a fund’s investment objective, I worry existing shareholders can end up with unintended exposures. And this only seems like a subtle change.”
Interestingly, neither the website for LARE nor the Tierra Funds website make knows the impending index change. While recent SEC filings do reflect the in prospect change, the websites investors often turn to when researching a stake are silent on the matter.
“Woe be to any investor who stumbles on the Tierra Funds website rational now,” said Nadig. “They’d have no reason to believe that the support will invest in anything other than Mexican and Brazilian REITs for the foreseeable tomorrows.”
— By Lara Crigger, ETF.com. Contact Lara Crigger at [email protected]