Thai ETFs: Fully Replicated or Optimized?

An exchange traded fund (ETF) is a pooled investment vehicle that holds a basket of securities with the goal of tracking an index or asset class. Although I published it only a couple of weeks ago, my guide to ETFs in Thailand has already received a good deal of attention.

One reader emailed me to ask if Thai ETFs are fully replicated or optimized.

The short answer is a “bit of both”.

Most (but not all) ETFs listed on the Stock Exchange of Thailand (SET) seek to track an index.

There are two strategies that a fund manager can use to achieve that goal:

Full Replication: Buying all of the listed securities that make up an index, and in exactly the same percentage holdings as the index.

Optimization: Buying only the listed securities that provide the most indicative sample of the index.

Full replication ensures that an ETF delivers exactly the same performance as the index that it tracks. But the catch is that full replication may not always be the most cost effective means of achieving that result.

The SET is an emerging market and, as such, it consists of a large number of small-cap companies and a handful of market giants. Unlike the market giants, some small caps will have minimal influence on an index but can still be costly to acquire. Mindful of this situation, it is unsurprising that many Thai ETF managers therefore elect to include the option to use both full replication and optimization strategies in their fund’s statement of investment policy.

Having a “bit of both” investment policy empowers a fund manager to employ optimization should it be deemed a more prudent strategy. That is, identifying and acquiring cheaper securities that offer the same, or superior, tracking outcomes, rather than purchasing all of the securities required to fully replicate an index.

The stated investment policy for Bangkok Bank’s BCAP MSCI Thailand ETF provides a relevant example:

Invests in equities listed on MSCI Thailand ex Foreign Board Index including assets which are in the process of being listed and delisted from the index, averaged in an accounting year not less than 80% of the NAV. The fund is fully invested in equities and may use Full Replication or Optimization strategies.

Before you invest in a Thai ETF, make sure that you first read its prospectus. Take care to read the stated investment policy and to review the fund’s historical performance. Keep in mind that an optimized fund can both out perform, and under perform, the index that it is tracking.

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