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In recent years, exchange-traded funds (ETFs) have grown rapidly. The ETF is considered one of the most successful inventions in the history of investment finance. ETFs first came to Vietnam in 2008, through foreign funds. Because these funds have grown so large, each ETF portfolio review now causes big swings in the market. So what is an ETF? And how do ETF rebalancings affect the stock market? Let us find out in the article below.
How do ETF rebalancings affect the stock market?
What is an ETF?
An ETF (Exchange Traded Fund) is a fund that tracks a basket of investments. It is designed to replicate the return of an index of stocks or bonds, or of an asset or commodity such as gold, exchange rates, oil prices or the VN30 index.
ETFs share the features of ordinary investment funds. However, they are treated like stocks, because they are listed and traded on the stock exchange. ETFs originated in the United States in the 1990s. Today, they are widely known in many countries around the world, including Vietnam.
The main types of ETFs
There are three typical types of ETFs in the stock market: equity ETFs, bond ETFs and sector ETFs. Each has its own distinct characteristics:
- Equity ETFs: funds that replicate the movements of stock indices in the market, such as the VN100, VN30 and S&P 500.
- Bond ETFs: likewise, bond ETFs replicate the movements of bond indices, such as government bonds, corporate bonds and other potentially high-yielding bonds.
- Sector ETFs: funds that replicate the movements of a specific industry or sector in the market, such as machinery, food technology or industrials, or of a specific commodity.
Besides these three typical types, there are also currency ETFs, inverse ETFs and alternative investment ETFs, among others.
ETFs in Vietnam
There are quite a few ETFs in Vietnam today; below are some of the larger ones with a significant impact on the Vietnamese stock market:
- The FTSE Vietnam Index ETF, which tracks the FTSE Vietnam All-Share Index, made up of stocks accounting for 90% of market capitalization, and the FTSE Vietnam Index.
- The VanEck Vectors Vietnam ETF, which tracks the MVIS Vietnam Index.
- The iShares MSCI Frontier ETF, which tracks the MSCI Frontier Markets 100 Index.
- The VFMVN30 ETF, which tracks the weightings of the VN30 index.
- ……
How does ETF rebalancing affect stock prices?
In an ETF’s operations, two kinds of events make the fund buy or sell stocks in its portfolio, and so affect their prices.
Buying and selling driven by fund flows
Buying and selling driven by fund flows is characterized by the stocks’ weightings staying the same after money flows in or out.
Example: ETF X has a NAV of VND 1,000 billion, with stocks A and B each weighted at 50%, or VND 500 billion each. After an inflow of VND 100 billion in cash, fund X’s NAV rises to VND 1,100 billion, and its assets consist of:
- VND 500 billion of stock A
- VND 500 billion of stock B
- VND 100 billion in cash.
Because the portfolio weightings have not changed, fund X has to invest the new VND 100 billion in cash to keep tracking the index accurately. Fund X will buy another VND 50 billion of stock A and VND 50 billion of stock B, which may push up the prices of A and B in the short term.
Buying and selling driven by periodic reviews
ETFs regularly review their weightings to assess how well the portfolio tracks the index. When weightings need adjusting, the ETF buys stock A and sells stock B so that total assets stay the same (since the fund has no new money). This is called rebalancing, or portfolio reallocation.
Example: fund Y has a NAV of VND 1,000 billion, with stocks A and B each weighted at 50%, or VND 500 billion each. After the review, the fund raises stock A’s weighting to 60% and cuts stock B’s to 40%. Fund Y then rebalances its portfolio by selling VND 100 billion of stock B and buying VND 100 billion of stock A. In the short term, this may push up stock A’s price while pushing down stock B’s.
Happy Trading!
>> Learn more about: Investment funds – exchange-traded funds (ETFs)
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