One active ETF outperformed its underlying index by more than 9% points over the past year.
In other words, its manager selected stocks well and delivered better performance than the index.
Yet this ETF disappeared from the market on the 19th. Why was a product with strong returns removed?
3-Line Summary
1. This ETF was delisted because of its correlation coefficient, not its returns.
2. An active ETF is delisted if its correlation coefficient remains below 0.7 for 3 months.
3. What to check is not the return, but the asset manager’s notices.
Below 0.7 for Three Months Leads to Delisting
Timefolio Asset Management’s “TIME U.S. Dividend Dow Jones Active ETF” was delisted on the 19th. Trading was suspended from the 18th, the day before, and redemption payments were made to investors on the 21st. The reason for its removal was not poor returns. It was a metric unfamiliar even by name: the correlation coefficient.
First, a word about the product. An ETF is a fund that bundles multiple stocks and is bought and sold like a stock. An index ETF is designed to track an underlying index such as the KOSPI200. An active ETF is different. Its manager seeks to outperform the underlying index by holding more of stocks it considers promising or adjusting portfolio weights. From an investor’s perspective, it is like entrusting money to a manager with the request: “Manage it better than the index.”
The correlation coefficient is a number that shows how similarly an ETF moves to its underlying index. It is calculated by comparing day-to-day rates of change, rather than the size of returns. Under current rules, an active ETF must be delisted if this figure remains below 0.7 for 3 months or longer. Products are reviewed based on their movements over the most recent 1 year, beginning after 1 year has passed since listing. The purpose of the rule is to protect investors by preventing managers from operating too differently from the investment approach they initially presented.
So how did this product perform? As of May 14, its return over the most recent 1 year was 36.06%. That was 9.42% points higher than its underlying index.
Delisting does not mean the money invested disappears. Trading stops, and investors receive a cash redemption payment calculated based on the net asset value (NAV) at that time. However, if that amount is below the price at which the investor bought the ETF, the loss is still realized. Delisting itself does not create a loss, but it does not prevent one either.
It Moved Away From the Index While Trying to Make Up Ground
According to a report by the Seoul Shinmun, an official at the Korea Exchange explained that this ETF had not moved independently of the index from the beginning. The official said, “Its performance relative to the underlying index had been poor since the end of last year, and it sought to raise returns, including by holding stocks not included in the underlying index, but its correlation coefficient worsened.” In other words, it held stocks outside the index to catch up on lagging performance, and as a result, its similarity to the index broke down. Its attempt to improve performance became the cause of violating the rule.
This was not the first case. Last month, 4 types of active ETFs managed by Korea Investment Management were delisted for the same reason. These too were products that had generated higher returns than their underlying indexes over the most recent 1 year.
Industry observers have raised the question of whether it is appropriate to apply a rule requiring products designed to outperform an index not to move too differently from it. There is also the perspective of those who created the rule. If products operated differently from their stated strategies are left in place for a long time, investors may no longer know what they bought. The most notable point in this case is that both arguments, though opposed to each other, cite investor protection as their basis.
Financial authorities are also aware of this issue. They are pursuing the introduction of “fully active ETFs,” which would not be subject to correlation-coefficient rules. The idea is to create products evaluated solely on management performance, without considering how closely they resemble their underlying indexes. However, introducing this system requires a legal amendment. Recently, discussions have not gained momentum as other pending issues, including follow-up measures for single-stock leveraged ETFs, have overlapped. It has not yet been decided when the system will be introduced. Until then, more active ETFs could disappear for the same reason.
What Should I Check for the ETF I Own?
First, let’s clear up one misunderstanding. A large excess return does not mean an ETF is closer to delisting. What the rule examines is not the return gap, but how closely the direction of daily price movements matches the index. Even if an ETF earns far more than the index, its correlation coefficient remains sound if it moves alongside the index. Conversely, an ETF’s returns can be similar to the index while its correlation coefficient alone breaks down because the stocks it holds differ. The two figures must be considered separately.
So where should you check? The correlation coefficient is not a figure investors can calculate on their own. Instead, when a delisting condition is triggered, the asset manager and the exchange announce it through disclosures. For this product, the Timefolio notices first posted the delisting schedule and later posted the finalized redemption amount, in that order. The same information is also available through the Korea Exchange Listing Disclosure System. If you own an ETF with “active” in its name, it is better to bookmark these 2 places rather than relying on the returns screen.
It is also useful to know what can be done after a disclosure is posted. Until the trading suspension date, investors can sell directly in the market; if they leave the ETF as is, they receive a redemption payment based on NAV. Which option is more favorable depends on the gap between the market price and NAV at that time, so it cannot be decided in advance. For an actual calculation, it is more accurate to check with the securities firm through which you trade. But if you miss the disclosure, you lose the opportunity to choose altogether.
Active ETFs were created not to track an index exactly, yet they are subject to rules that can remove them if they differ too much from the index. Until this mismatch is resolved, it is difficult to feel reassured by return figures alone. For now, opening the notices board one more time is the surer choice.
References
- Seoul Shinmun
Tags #ActiveETF #ETFDelisting #CorrelationCoefficient #UnderlyingIndex #ETFInvestment #FullyActiveETF #ETFRegulation #TimefolioAssetManagement #KoreaInvestmentManagement #ExchangeTradedFund #IndexETF #ETFRedemptionPayment #NetAssetValue #ETFDisclosure