Filtering the universe of stocks

Exchange-traded funds (ETFs) are appearing more and more in the Australian market. As (generally) index funds whose units are quoted and traded on the ASX like shares, they are often presented as a sleek, glossy package of investment potential for SMSFs and other retail investors. Beneath the glossy exterior though is generally a powerhouse of detailed analysis worthy of consideration by retail and sophisticated investors alike.

It is worth noting that ETFs are considered by ASIC to be complex financial products. Some are more complex and risky than others. For more information on ETFs and risks associated with them, see ASIC’s Moneysmart website at https://www.moneysmart.gov.au/investing/complex-investments/exchange-traded-products

While the specific analysis undertaken will differ from product to product, for ETFs that are designed to track purpose-built indexes, it tends to be a complex process that combines quantitative and qualitative analysis. Here, Arian Neiron, Managing Director of Market Vectors Australia, explains to Canstar how the universe of Australian shares is filtered to just 76 by Market Vectors Index Solutions, for the new VanEck Vectors Australian Equal Weight ETF.

“The new equal weight fund”, Arian explains, “is designed to eliminate the risks of stock concentration and sector concentration by giving each stock held in the portfolio an equal weighting. In this way the Fund diversifies away from mining and financial sectors, which dominate the Australian market, into the other sectors of the market (click here for more information).

“Our Australian Equal Weight ETF (ASX code: MVW) tracks the Market Vectors Australia Equal Weight Index, developed by our index company, Market Vectors Index Solutions. As a first step MVIS looks at the whole universe of Australian equities, which is about two and a half thousand securities,” says Arian. “Then they get rid of what I call the ?rats and the mice?; all the stocks with a market capitalisation of around $50 million or less.

“Next they apply something called ?pure play?, a concept pioneered by Lars Hamich, Managing Director of MVIS” continues Arian. “Essentially this means they ignore the standard global industry classification system for stocks and instead, look at where a company is located, where the revenue is coming from and where the assets are held.

“At a country level, the pure play concept looks at off-shore companies that are incorporated outside Australia and listed on the ASX that derive more than 50% of their revenue or have more than 50% of their assets in Australia. In this instance, these companies would be included in the Equal Weight ?index universe?.

By this stage, after removing the ?rats and mice? and applying the ?pure play? test, the ?index universe? contains around 570 stocks.

“The next step is to derive the ?investable index universe?. MVIS takes the ?index universe? and applies stringent liquidity screens to determine the most liquid companies in the index universe,” says Arian. “They look at the average daily trading volume and the average daily trading value of each company over the previous three quarters. To pass the screens and qualify for inclusion in the investable index universe, each company has to satisfy thresholds of one million dollars per day and at least 250,000 shares traded per month over the previous nine months. That process brings down the number of potential candidates for inclusion in the index to around 195 securities.

“Then MVIS sums up all the securities and ranks them from number one down to number 195 in terms of their free-float market capitalisation,” Arian continues. They set a minimum target coverage of 90% of the free-float market capitalisation of the investable index universe with at least 25 companies in the final ?index basket?. Stocks are then included in the basket until that coverage is achieved.  This currently reduces the list from 195 to 76.

“Finally a capping methodology is applied to further enhance diversification. In the case of Equal Weight, each stock in the index basket is given an equal weighting within the portfolio. This is how MVIS builds the Australia Equal Weight Index.

“At Market Vectors Australia, we have launched the Australian Equal Weight ETF (ASX code: MVW), that aims to track the performance of that MVIS index. MVW invests in the same companies as determined by the Index. So MVW in turn holds a portfolio of 76 stocks, with each stock representing 1.32% of the overall value of the Fund. The index is reviewed and reweighted, in other words the whole process is repeated, on a quarterly basis. Any changes to the Index are then also implemented by us to the holdings in the Fund.”

IMPORTANT NOTICE

Any advice on this page is general and has not taken into account your objectives, financial situation or needs. Consider whether this information is right for you. Consider the product disclosure statement and seek advice from a licensed financial adviser before making any investment decision. See our detailed disclosure.

General information only

Market Vectors Investments Limited ABN 22 146 596 116 AFSL 416755 (Market Vectors Australia) is the Responsible Entity of the Market Vectors Australian Equal Weight ETF (MVW). This information is general in nature and does not take into account your objectives, financial situation or needs (your circumstances). Before making an investment decision in relation to MVW you should read the product disclosure statement (PDS) and with the assistance of a financial adviser consider if it is appropriate for your circumstances. The PDS is available at marketvectors-australia.com or by calling 1300 MV ETFS.

About Van Eck Global

Market Vectors ETFs are sponsored by Van Eck Associates Corporation (Van Eck Global). Founded in 1955, Van Eck Global was among the first US money managers helping investors to achieve greater diversification through global investing. Today, the firm continues this tradition by offering innovative, actively managed investment choices in hard assets, emerging markets, precious metals including gold, and other alternative asset classes.

About Market Vectors

Market Vectors exchange traded products have been offered since 2006 and span many asset classes, including equities, fixed income (municipal and international bonds) and currency markets. The Market Vectors family totalled US$23.6 billion in assets under management, making it the eighth largest ETP family in the US as of 28 February, 2014.

About Market Vectors Index Solutions

Market Vectors Index Solutions (MVIS) develops, monitors and licenses the Market Vectors Indices, a selection of focused, investable and diversified benchmark indices. The indices are especially designed to underlie financial products. Market Vectors Indices cover several asset classes, including hard assets and international equity markets as well as fixed income markets and are licensed to serve as underlying indices for financial products. Approximately US$11.1 billion in assets under management are currently invested in financial products based on Market Vectors Indices. The Market Vectors Australia Equal Weight Index is the exclusive property of MVIS. MVW is not sponsored, endorsed, sold or promoted by MVIS.

Market Vectors Australia and MVIS are wholly-owned subsidiaries of Van Eck Global. No member of the Van Eck Global group of companies makes any representation regarding the advisability of investing in MVW or any other Market Vectors ETFs.

Market Vectors® and Van Eck® are registered trademarks of Van Eck Global.

Further information about Market Vectors Australia is available at marketvectors-australia.com