Today I ran into an interesting situation which reminded me why we set out on this journey to help DIY investors, like myself, research and understand investments.
A new cloud computing ETF has launched, as someone who currently holds a cloud computing ETF I figured it would be interesting to look at the differences.
As the ETF had just launched it doesn't have enough performance data for me to run it through the ranking algorithm, but it shouldn't take me too long to read through the documents, should it?
Rules of Engagement
I'm sure we are all familiar with the KIID, Key Investor Information Document, you have to tick a box saying you have read this before you buy any fund. They have a standard structure and should explain what you are getting yourself in for. The idea being this is an apples to apples comparison.
To make sure it's as similar as possible I picked the USD share class for both funds. Even ETFs have share classes, something to watch out for, it's common to get different currency versions or Income versus Accumulation.
State Your Purpose
First thing I want to check, these are both passive ETFs, so what index are they tracking?
Under the objective and investment policy you can find the two respective indexes being used, it's normally the first point under objective.
We have the "ISE CTA Cloud Computing Index" and the "BVP Nasdaq Emerging Cloud NTR Index" respectively. Both roll off the tongue and give me absolutely no idea what I'm investing into.
I've had to visit the websites for both providers to get the index explanation. Funnily enough both are indexes provided by Nasdaq.
So, what's the difference?
For First Trust an equity must be classified as a Cloud Computing company by the Consumer Technology Association. Again, not sure who those guys are but it seems pretty official, they have some extra rules but nothing too note worthy. For WisdomTree an equity must derive the majority of its revenue from business-oriented software products via a cloud delivery model. Given "the cloud" is just someone's computer that is pretty broad too.
Keep in mind this isn't in the KIID, but fundamentally the two investments have very different rules for what companies make the cut.
The other interesting thing is how these equities are weighted, both indexes are equally weighted. Yet, First Trust doesn't have equal weights. Turns out First Trust modify the index with a scoring system about how "cloud" you really are.
This is odd as the KIID for First Trust says they are attempting to replicate the performance of the index, but really they are completely changing from the index weighting to their own weights.
WisdomTree's KIID is much clearer in this regard, it says it has an equal weighting, and they are open that it's representative sampling. Then again, much clearer doesn't mean it makes sense, representative sampling of an equally weighed index?
Finishing off the tasty bits in the objectives section, both ETFs offer a recommendation. This fund is not suitable for anyone looking at short-term investment. Which is about as helpful a recommendation as telling me what soup the fund managers enjoy. MiFID II has introduced some extra information in this area, a recommended holding period, but good luck getting an EMT document from any fund provider which is up to date or makes sense.
The biggest and most eye catching part of a KIID, this is what you likely look at whenever you open one of these documents.
They both plan to invest in similar companies, they both have roughly the same objective.
First Trust has a risk rating of 6/7 and WisdomTree a risk rating of 7/7.
Even better, they both give the same reasons for their different scores. High concentration risk into a volatile sector.
WisdomTree mention some extra risks about the fund but it's boiler plate stuff that First Trust have stuck on their website.
We have an ETF that completely changes the weightings, but is trying to match an index, and an ETF that does sampling on an equally weighted index.
This is the joy of the risk and reward section in the KIID, the fund manager can set this based on their own rules and logic.
Also known as the bit with more clauses than an American mall during December.
Sadly this section really highlights the issues with reporting fund charges, there isn't a clear standard about what to show.
Entry and Exit fee for First Trust is "None" but for WisdomTree it's 3%. I know for a fact, this 3% charge is simply not true. Why is it showing up as 3%?
On WisdomTree's KIID they have a note under the fees that says, this is the charge if you deal directly with the fund, in some cases you pay less.
However, this is an ETF, you don't buy directly, you are trading on the secondary market primarily with the market makers. This 3% is extremely unlikely to ever apply to a retail investor.
It then gets even stranger, the First Trust "None" also has a clause. It says it's none in the secondary market (correct) however anyone dealing with the fund directly can expect a fee of up to 3%.
Both have the absolute same entry and exit fee but display them differently! First Trust have assumed you are a typical retail investor, whereas WisdomTree has a KIID that assumes you trade directly with them. This is an odd decision as WisdomTree doesn't offer UK based investors the opportunity to investor directly through their own channels.
Neither have a performance fee or any interesting clauses around performance, we can skip ahead to the tasty bit, the ongoing charges.
First Trust is 0.60% and WisdomTree is 0.40%.
However, let's read those clauses.
For First Trust if the expenses go above 0.60% the fund manager will have to cover the costs, not the investors. It's also clear that this fee covers all operational costs.
WisdomTree is a bit different, the ongoing costs will vary year on year, and it excludes portfolio transaction costs, meaning these are added separately and not disclosed here. There are more rules around the charges for both of these ETFs but they are hidden away in the prospectus.
Neither have any past performance due to the regulators laws around minimum active trading history before showing a graph. However, the First Trust ETF does have a five year history just not in this share class, and KIID is per share class.
Honey I Shrunk The KIIDs
All in all, the documents weren't as helpful as you would hope. Most of the interesting information was on their website, like the holdings for instance. That showed some very big differences between what kinds of investments they hold and actually explained how the fund picks and allocates the equities.
Going through and trying to make sense of the KIIDs reminded me why we got into making Genuine Impact. Trying to cut through the noise to what matters to you as an investor.
The next version of the app has heaps more information on funds (like these ETFs) and I know the whole team are really excited to share more details with you.
I'm looking forward to the day I don't have to decode the KIIDs!
Alister Sneddon - October 18, 2019, updated January 20, 2020