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Tuesday 12 March 2019

CoreShares - Thanks But No Thanks

Tough choice 
Us buy and hold ETF investor’s lead pretty boring investment lives. Once we have settled on the ETFs we like, we simply continue buying them month in and month out, and we never have to sell.

This means that nothing exciting ever really happens (although some of us may have been caught doing a happy dance when ETF dividends land - but that's as much excitement as you'll get!)

So when one of the providers of a ETF we hold proposes changing the name and methodology of the ETF, it can really shake us up! Suddenly we are awoken from our investment slumber.

But before diving in to the changes CoreShares are proposing for their Equally Weighted Top 40 ETF, let’s start at the beginning (some say it’s a very good place to start).

What Is The CoreShares Equally Weighted Top 40 ETF?

The CoreShares Equally Weighted 40 ETF is one that I, and many others, have been buying as one of the cornerstones of our investment portfolio’s. In short it is an ETF that holds South Africa’s 40 biggest companies, with each company making up an equal part of the ETF.

In other words each company makes up 2.5% of the ETF (40 x 2.5% = 100%. Yes? Who said we would never use our Grade 6 Maths again!)

This makes it a really good ETF to use if you want to get exposure to South African shares because it is nicely diversified (40 companies remember) and there is no single company risk (unlike the Satrix 40 for example, which holds around 21% in Naspers).

So the CoreShares Equally Weighted Top 40 ETF is:
a) Easy to understand
b) A great way to get diversified exposure to South African equities

So there we were, buying our CSEW40 (that’s what the cool kids call it) ETFs, minding our own business. But then...


CoreShares hit us with some news. They are proposing some changes to the name, the index the ETF tracks (which meant a new methodology) and the fee.

Let’s check it out…

So What’s Going To Change?

You can find more detail around the changes in this document which CoreShares released as well as in the official SENS announcement over here.

The way I understand the changes is summarised below:

Immediately after the proposed changes were announced, I received some emails and tweets from the blog's readers (man you guys are on top of market happenings!) asking what I thought and what to do.

Okay, let me first address the what to do part first…

X Marks The Spot

Reading between the lines of some of the queries I received, the first thing that people may be unaware of is that these changes are proposed changes – it is not a sure thing yet.

You see there are a whole bunch of rules around ETFs (and Unit Trusts for that matter) changing their benchmarks, methodologies, mandates etc. And this is a good thing – I can only imagine the chaos if people could just update these things according to how many sugars they had in their coffee that morning. (For the record – I don’t add any sugar to mine, I’m sweet enough!)

So the rules are that the investors of the ETFs have to vote for or against the proposed changes. If there are enough yes votes, then the proposed changes will be implemented.

So that is the first thing you should do – vote! Proudly pledge your allegiance!

If you like the changes, vote for it, and if you don’t like them, vote against it.

Your broker should be sending out emails/making links available shortly to allow you to cast your vote.

The weighting of your vote will be determined by the size of your investment in the CSEW40 ETF (the votes aren’t equally weighted like the ETF :-P). So the more of the ETF you hold, the more your vote counts.

There are also some rules about what determines a valid outcome from the vote. If votes representing more than 25% of the value of the ETF are received, then the simple majority wins. If there are more yes votes than no, then the changes will be implemented (and if no wins, then the ETF stays the same).

If less than 25% of votes are received, then a second vote will happen. In the second vote there is no minimum requirement (so even if only one person votes, the result will be valid and final).
So I say again – make sure you vote. Let’s get this thing over with the first time round :)

In terms of timelines, your vote needs to be submitted by 1 April 2019.

I’m Voting No, And Here’s Why

For those wondering, I will be voting against the proposed changes. But I must stress that this should not be a factor in deciding which way you will go. You need to make your own mind up about that. In fact, before you continue reading about my reasons for voting no, I encourage you to listen to this Just One Lap podcast by Simon Brown, where he spoke to one of the CoreShares peeps and gave his reasons for voting yes.

Okay, let me detail why I am voting no…

1.) I Think The Timing Is Bad

One of the reasons CoreShares gave for moving from an equal weight index to this new index, is that although equal weight outperforms over the long term, there are periods where it under-performs (and trust me, I believe them when they say that – just look at the last few years!)

I pulled this chart from their doc which they use to illustrate their point:

As you can see, over a 3 year period, the Equally Weighted ETF outperformed 45.7% of the time. Over 7 years, that improved to 60%. Their point is, that there are periods where the equal weight under-performs. Their observations around this is that investors get impatient when they see their ETF which is supposed to outperform, start under-performing, and so they sell out and go find something else.

Of course these periods of under-performance mean that there will be periods of out-performance (and significant out-performance) in order to get back to the long term expected result. And because the investors sell out and end up missing out on the periods where they would have achieved very generous returns.

CoreShares say they want to help investors avoid this by smoothing out the ride for them (and increasing their odds of out-performance over shorter time frames).

I find it a little ironic then that they are proposing this change right at the time where there has been a significant period of under-performance. In other words they are now forcing even the patient investors to effectively sell-out of the ETF right at what is probably the worst possible time to do so.

I’m sorry but I have been waiting patiently for the period of out-performance to arrive, and it will come! In fact, after such a drawn out period of under-performance, I am pretty sure the good time are imminent. So, after waiting patiently for so long, I am less than impressed that CoreShares want to deny me my day in the sun.

2.) WTF Is Going On Under The Hood

The current Equally Weighted ETF is pretty easy to understand. You take the top 40 companies and you buy 2.5% of each. Nothing much to it.

Fortunately the new ETF will also be super easy to understand. All they are doing is constructing 6 sub-indices according to a set of rules which define mid-capitalisations, low volatility, high momentum, high profitability and low investment, and then combining those results by simply applying the Scientific Beta diversified multi-strategy weighting scheme to ensure maximum deconcentration, maximum decorelation, efficient minimum volatility, efficient maximum Sharpe ratio and a diversified risk weighted portfolio. Pretty basic.

Me? Sarcastic? Never?

One of the blogs readers put it very nicely – “Point being, I understood the ETF before, and now I don't.”

3.) Additional Costs

Maybe it’s just me, but I am sucker for decreasing fees (and therefore, conversely, increasing fees suck)

If the change is implemented, the management fee will be going up from 0.3% to 0.4%. While 0.1% may not seem like a train smash, the way I see it is that it is a 33% increase.

And then of course there will also certainly be an increase in transaction activity within the fund as they drop the companies that don’t make the cut, adjust the weightings of existing companies according to the new index, and take positions in the companies that need to be added. That is almost certainly going to bump up the transactions costs significantly in the first year after the changes. Who do you think pays for that?

4.) I Am Not A Fan Of Smart Beta

I know I know, the Equally Weighted 40 was kinda a smart beta product. But certainly not to the extent that the new version will be.

I mentioned it in this interview I did with Quintus Potgieter from Quintessential Finance – but I am not a huge fan of smart beta. Nor is Jack Bogle - I recall an interview with him where he mentioned that smart beta always seems great in theory, but in practice it often doesn’t play out the same way.

And then two things I believe with regards to investing:
  1. Trying to be too clever often leaves you looking stupid.
  2. Trying to outperform means there is a very real risk that you will under-perform
Yes the proposed ETF has done well historically, but whose to say that it will continue?

We also need to view this out-performance in terms of the extra fees. Remember that the new ETF will need to out perform the current ETF by 0.1% each year, every year for the rest of my life (remember how us boring ETF investors generally don’t sell ETFs). Of course it could well do that, but it could very well not…

And finally, something which I spotted in their SENS announcement

“These diversification techniques may be adjusted from time to time. New techniques may be introduced or existing techniques taken out of the methodology.“

In other words, they will be allowed to change the diversification techniques they use depending on the phase of the moon and wind direction from time to time at their discretion. Seems the product could be walking pretty close to the dark side active management…

5.) Speaking My Mind

I bought the Equally Weighted 40 for a reason. I liked the Top 40 companies in equal weight as it reduced the single company risk of a vanilla Top 40 ETF. I want CoreShares to know that I have a strategy and understanding of my investments and I don’t appreciate them messing with it. My no vote tells them this.

And I want them to know this, because I still hold their Proptrax 10 ETF as well. And that’s an Equal Weight product. So will that one be next in line to get the Smart Beta treatment? (Although to be honest that might just be the final straw to convert all my existing Proptrax 10 to Satrix Property as I started alluding to in this article.)

6.) Other Unwanted Side Effects

There are also two unwanted side-effects that, should the change go ahead, could cause some inconvenience and cost some investors money (okay to be honest there is only really one, the second one is just my laziness coming out)
  1. If the change goes ahead, and an investor is not happy about it, and wants to move products, they are going to have to foot the bill for moving (selling and re-buying ETFs costs money – spreads, brokerage etc.). And then on top of this, someone who has held the product for a long time could well incur CGT on the sale of their CSEW40 ETFs. That’s not cool – you will be taxed for a move you did not want to make.
  2. And then purely thinking about number one here, but, if the change goes ahead I am going to have to update all my old blog posts where I mention CSEW40!
I saw someone on Twitter mention that if CoreShares wanted to launch this smart beta product they should have done it as a new product. Although I understand the business case for not doing it that way, I tend to agree with the tweet. That would have solved both of the problems above (and in fact all of the issues I have with changing the CSEW40)

Okay, so those are my reasons for voting no. Now let’s talk a little about my thoughts around what happens if the change is approved.

Thinking Ahead - What If The Change Is Approved?

Although it’s far from a done deal, I have started mulling over what I would do in the event that the changes do go ahead…

First and foremost, I definitely won’t be buying any of the new product. As mentioned I don’t like the whole smart beta idea, the extra fees and the complicated approach (which they are able to change at their discretion).

This means that I would need a new ETF if I wanted to increase my South African equity exposure. So what are the alternatives?

The first one that came to my mind was the CoreShares Top 50. It has a cap to reduce single company risk, and is pretty well diversified. But then….. whose to say that CoreShares aren’t going to want to tinker with that one as well? (I think you can detect that this whole thing has caused me to lose quite a bit of trust in CoreShares).

So what else?

Man, as much as I try look elsewhere, my eye keeps coming back to the simplicity and low cost of the Satrix 40. That TER of 0.1% (which means it’s total cost is the same as what CoreShares plans to increase their cost by!) makes me weak at the knees…

Yes I hear what you saying – Naspers at 21%!

But maybe it’s not so bad…

Remember, that any investment that I make into the Satrix 40 will form only a small part of my overall portfolio (which includes my work pension, my preservation fund, my companies share matching scheme and other ETFs). So lets say I end up holding 10% of Satrix 40 in my overall portfolio, then that Naspers becomes only 2.1% - that’s no problem!

Okay, so I guess going forward, any of my new buying targeted at South African equity exposure will be done through the Satrix 40. (For the record, some of the other options you could look at for South African Equity exposure include the Ashburton Mid Cap, Absa NewFunds S&P GIVI SA Top 50, Satrix Rafi, Sygnia Itrix SWIX 40, CoreShares Dividend Aristocrats (although whose to say that one won’t be up for changes in future – maybe I am too cynical…))

So that leaves one last dilemma – what to do about my existing CSEW40 holdings?

As I mentioned, selling out and buying into a new ETF costs money. So I am torn between:
  • Moving all my CSEW40 holdings over to the Satrix 40 – or while I’m at it, maybe even move it into the Satrix Worldwide in order to up-weight my international allocation as I mentioned I wanted to do in  this article. Or..
  • Just leaving it as is and, as time goes by, my CSEW40 (or SMART as it will be called if the changes happen) will naturally start to form a smaller and smaller part of my overall portfolio…
Tough one, and I remain undecided for now… Guess I will cross that bridge if we get there. Let’s first see what happens with the voting.

Ballot Time

A lot of people were suggesting that CoreShares should have rather just introduced a new ETF instead of trying to panel beat an existing one into this new methodology. I guess that's a fair point. CoreShares response was that it didn't make business sense for them to do it that way.

Either way, democracy rules in the end, and the people will choose...

Just in case you are undecided whether you should vote or not, I put out a poll on Twitter to gauge the feeling out there, and (even thought it's a small subset) it seems to indicate that it could end up being a close run affair! Your vote could be difference!

I just want to re-iterate that this article is not meant to tell you how to vote, that is up to you. But I would love to get your thoughts - will you be voting yay or nay? What’s your thinking and reasons behind your decision?

If you don’t want to share your view that’s okay too, I guess we can just add one one more off-limits dinner table topic of conversation - religion, politics, and (now) which way to vote for the CSEW40 changes J

Till next time, Stay Stealthy!
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