Industry Updates

BlackRock to fully replicate three ETFs to avoid tracking error

At risk of being ‘unable to hold the full weighting of constituents in the index’

Theo Andrew


BlackRock is to start fully replicating the underlying index on three ETFs including a digital entertainment strategy as well as US and emerging market equity ESG ETFs.

In a shareholder notice, BlackRock said the investment strategy for the iShares MSCI USA ESG Screened UCITS ETF (SDUS), the iShares MSCI EM ESG Enhanced UCITS ETF (EDG2) and the iShares Digital Entertainment and Education UCITS ETF (PLAY) will be switched to fully replicating.

Currently, the three ETFs follow a non-replicating strategy – also known as an ‘optimised’ approach – meaning they can choose whether to hold every stock in their underlying index, and the weighting of each.

This allows them to mirror the index as closely as possible without fully replicating the underlying benchmark, however, the asset manager said it ran the risk of not being able to hold the full weighting of the benchmark index.

BlackRock said: “Should the fund continue to follow a non-replicating investment strategy, it could be at risk of being unable to hold the full weighting of constituents in the index which would consequently increase the fund’s tracking error against the performance of its benchmark index.

“The fund's index tracking investment strategy will therefore be changed to a replicating investment strategy which will allow the fund to replicate as closely as possible the composition of the benchmark index and permit the fund to avail of higher investment limits.”

By following the optimised approach, the ETFs adhere to the 5/10/40 rule for UCITS which means the maximum weight to a single security can be above 10% only if the top four holdings do not exceed 40%.

When the ETF tracks an index with a single weighting above 10% they are required to track away from the index to remain UCITS compliant.

However, by becoming fully replicating, SDUS, EDG2 and PLAY will move to the 20/35 rule, meaning they can take higher concentrations of up to 20% in a single security.

This limit can then be raised to 35% in a single issuer during exceptional circumstances such as when one issuer exhibits dominance within their respective market.

The changes will take place on 15 August, subject to approval from the Central Bank of Ireland.

In March, BlackRock made the same changes on two ETFs, the iShares Edge MSCI USA Momentum Factor UCITS ETF (IUMF) and iShares MSCI EM Consumer Growth UCITS ETF (CEMG).

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