What Happens When an ETF Gets Too Big for Its Index?

What happens when an ETF gets too big for its index?

This is not a hypothetical question.

Last month it was reported that the Junior Gold Miners ETF (GDXJ) had amassed $5.4 billion in assets, a level too large for its index. In order to avoid exceeding 20% ownership in a few of its holdings (which under Canadian rules would necessitate a takeover offer) and abide by IRS diversification requirements (which would jeopardize its preferential tax treatment), it was already deviating from its index, and by no small amount.

Five of its holdings (25% of its assets) were outside the index, including a position in another Gold Miner ETF: GDX (its 2nd largest holding).

List of Daily Holdings of ETF as of March 2017

VanEck (manager of GDXJ) responded by announcing changes to the ETF/Index starting on June 17. The new index will increase the market cap range of the underlying universe from a maximum of $1.6 billion to a maximum of $2.9 billion. This would result in 23 new companies being added to the index that could “represent as much as 60.8% of the new portfolio.”

How have market participants responded?

None too kindly. One of the top performing assets early in the year, GDXJ has declined 20% since the announcement.

2017 total returns of Junior Gold Miners

Investors don’t seem to be waiting for the changes to take place, with over $625 million in outflows since the announcement. That combined with the decline in share price has brought the AUM of the GDXJ ETF down to $4 billion (from $5.4 billion at the time of the announcement).

List of top 10 redemptions of all ETFs with Net Flows

Given the existing rules, VanEck had little choice in making the changes. But ironically, if these outflows continue, GDXJ may no longer be “too big for its index” by the time the index is changed. Perhaps the market would have eventually solved the issue on its own, by good old-fashioned supply and demand.

The broader question from this story is as follows: with the continued explosion of ETF/Index assets, will this soon become an industry-wide problem? I don’t believe so, at least not anytime soon. There will likely be another niche ETFs that face similar issues, but the largest broad-market ETFs (total stock and bond market) are a long way from outgrowing their indices:

  • The largest ETF in existence, SPY (S&P 500), has $238 billion in assets. The total market cap of the S&P 500 is over $21 trillion. So SPY is a little over 1% of the value of the S&P 500.
  • The largest bond ETF in existence, AGG (U.S. Aggregate Bonds), has $44 billion in assets, roughly 0.2% of the value of its index.

By comparison, at $5.4 billion, the Junior Gold Miner ETF was 18% of its benchmark universe.

In a future post, I’ll dig into this in more detail, examining other popular niches ETFs. But for broadly diversified ETF investors, the notion that GDXJ is a microcosm of the industry at large is patently false.

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This writing is for informational purposes only. It does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction. It also does not offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.



Charlie Bilello is the Director of Research at Pension Partners, LLC, an investment advisor that manages mutual funds and separate accounts.  He is the co-author of four award-winning research papers on market anomalies and investing. Mr. Bilello is responsible for strategy development, investment research and communicating the firm’s investment themes and portfolio positioning to clients. Prior to joining Pension Partners, he was the Managing Member of Momentum Global Advisors. He previously held positions as a Credit, Equity and Hedge Fund Analyst at billion dollar alternative investment firms.

Mr. Bilello holds a J.D. and M.B.A. in Finance and Accounting from Fordham University. He has also done a B.A. in Economics from Binghamton University. He is a Chartered Market Technician (CMT) and a Member of the Market Technicians Association. Mr. Bilello also holds the Certified Public Accountant (CPA) certificate.

You can follow Charlie on twitter here.

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