Vanguard is changing the benchmark of its FTSE Developed Asia Pacific ex Japan UCITS ETF after the rapid growth of South Korean technology companies increased concentration within the existing index.
The ETF currently tracks the market-cap weighted FTSE Developed Asia Pacific ex Japan Index, but will move to the FTSE Developed Asia Pacific ex Japan Daily Capped Index on or around 15 October. Vanguard said recent market movements, “particularly in the South Korean technology sector”, meant that continued increases in the weight of individual companies could cause the ETF to run into UCITS diversification limits.
The scale of the shift towards South Korea is considerable. At the end of August, the country accounted for 49.9% of the ETF, compared with 32.2% for Australia. Samsung Electronics’ ordinary shares represented 15.8% of assets and its preference shares a further 2.0%, while SK Hynix accounted for 12.3%. Together, Samsung and SK Hynix therefore represented around 30% of the portfolio.
The concentration has accompanied very strong performance. Vanguard’s UK data show the ETF returned 62.0% in the 12 months to the end of August, compared with 13.9% over the preceding 12-month period. Total assets stood at around $3.2bn.
The replacement index will retain substantially the same exposure to developed Asia-Pacific markets excluding Japan but introduce limits on individual holdings. The largest issuer can account for no more than 35% of the index, with other issuers capped at 20%. Vanguard said the change does not materially alter the ETF’s investment strategy or risk profile and that it will remain passively managed.
Our view
David Batchelor, senior analyst at QuotedData, said: “This is an unusual example of the success of a handful of stocks creating a problem for a passive ETF. The strength of Samsung and SK Hynix has helped drive a remarkable 62% return from the fund over the past year, but it has also left South Korea accounting for almost half of the portfolio and pushed individual company weights towards levels that could eventually conflict with UCITS diversification rules.
“The change illustrates one of the less obvious limitations of market-cap weighted indices. An ETF can begin with quite broad exposure but become increasingly concentrated as its biggest winners grow. Vanguard is not making an active call to reduce Korean technology exposure – the new benchmark is designed to preserve essentially the same investment proposition – but introducing caps should prevent further gains in a small number of stocks from creating a regulatory problem.”
