Most investors assume that ETFs are passive investment tools tracking independently calculated indices, that premise has arguably been one of the key factors driving the popularity of ETFs. In the past investors and advisors could be confident about their understanding of an ETF by reviewing the rules governing the underlying index. To a large extent this made ETFs the diametric opposite of most mutual funds (which are actively managed) because with ETFs you knew what you were getting via the index. Previously even self-indexed ETFs were required by the SEC to track independently calculated, rules based indices that publically disclosed their methodology and underlying constituents. This is no longer the case.
An entire crop of self-indexed “passive” ETFs are being launched where index transparency has been removed and instead only the holdings of the ETF need to be disclosed. Arguably these types of ETFs are no longer a reliable alternative to mutual funds and other active investment products. Alarmingly since these new “ETFs” are technically index based, they will probably enjoy a false association to ETFs that track independently calculated indices.
The philosophy behind passive index investing helped make the ETF into a trusted vehicle. To maintain that trust it will be more important than ever for investors and their advisors to demand ETFs tracking independently calculated rules based indices.
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