Under the Hood | What index are you tracking? And how is it made?

Bryce: [00:00:26] All right. Hello and welcome to another episode of Get Started Investing feed podcast where we attempt to answer the most common money and investing questions from the get started investing community in an attempt for us all to become better investors. If you're joining us for the first time, welcome, we do strongly recommend that you scroll up and start at episode one. Now, while we are licensed, we're not aware of your personal circumstances. All information on this show is for education and entertainment purposes. Any advice is general advice only. With that said, let's crack on. My name is Bryce and as always, I'm joined by my equity buddy, Ren. 

Alec: [00:01:03] How are you? I'm very good, Bryce. Excited for episode three of this Under the Hood series, Loving it so far and loving that it's not just you and I trying to navigate this world. 

Bryce: [00:01:15] Get a bit of a breather. No, we are. We continue our Under the Hood series with global ETFs. And it is our pleasure to welcome back our guest. In the first episode, Kanish Chugh, Head of Distribution. Kanish, Welcome. 

Kanish: [00:01:28] Hi. Good to be back. 

Bryce: [00:01:30] What a cracker for our First episode.

Alec: [00:01:33] And reviews are off the charts. Yeah, Yeah,.

Kanish: [00:01:34] I guess Ren, did you have the chicken burger after? 

Alec: [00:01:37] I didn't. I must say, as a celebratory for the end of the ten hour, and I'll.

Kanish: [00:01:43] Let me know. 

Alec: [00:01:44] If we keep talking about it. I might have to get multiple copies. 

Bryce: [00:01:47] Now, as you know, under the Hood is a series where we're answering the biggest investing question: How do I analyse an ETF? We have plenty of the Equity Mates community wanting to invest in ETFs, but there are plenty of different ways that you can go about analysing them. And this is a series where we take each episode and address one way in which you can analyse an ETF. And in today's episode we're asking the question, What index are we tracking? How is it made? Because it can be quite confusing at times. 

Alec: [00:02:18] Yeah, and the ETF that we're looking at to do this is Global X is Global Robotics and Automation ETF. The ticker is ROBO. And Kanish, like we do for a lot of these episodes, we have a question from the community that touches on this thing. 

EM Community: [00:02:34] Hey, Equity Mates, quick question. There are so many thematic ETFs out there, and I'm wondering who decides what goes into an ETF? For example, Who decides if Tesla's an ESG or not? 

Bryce: [00:02:44] Wow. Tough one. 

Alec: [00:02:45] The big one. Before we even get to question Tesla, ethical or unethical? 

Kanish: [00:02:51] Well, don't. Tesla passes ESG screens because it's you know, from a governance perspective, sustainability, social as such all those a screen. So in the basic sense, yes, it's ethical, I think. 

Alec: [00:03:09] Good answer.

Bryce: [00:03:11] But it's an interesting question. Kennish Because we've discussed a little bit in episode one about some of the major index providers, but understanding who makes those decisions and who decides what goes in. It's not something that we actually spend a lot of time talking about, but it is very important. 

Alec: [00:03:27] Well, I think the most common assumption is that it's the ETF issuer makes those decisions. It's Global X or it's, you know, any of your competitors who say ethical or unethical or technology, not technology. But do you ever make those decisions? 

Kanish: [00:03:44] Not in the portfolio sense, no. So that's where we would become active managers. Now, we currently don't have any active funds or active ETFs, and from our perspective, all of our ETFs track an underlying benchmark. So what that means is we've identified and chosen a benchmark with equities. We've essentially chosen a index and equity index. So that's representing a basket of stocks and we leave it up to that index and the rules of that index to decide what's in and what's not. 

Alec: [00:04:16] So then the question becomes, if it's not the ETF issue, we're making those decisions about what's in the index, who is it? 

Kanish: [00:04:23] So there are different index managers. So what is an index manager? Essentially, they are companies that have and manage those different indexes. You know, for the equities, it's a basket basket of companies. And you know, there are over 3 million indexes around the world. 

Alec: [00:04:40] What does should try and find the most niche indexes out. 

Kanish: [00:04:45] Well not all remember not all indexes are used for ETFs to track. So a lot of active managers will use them as reference benchmarks. So they will say, I'm trying to outperform the S&P ASX 200 index by 3%. So they still have to license that from that index manager. So that's why you have so many different types. You also have different indexes in different currencies. You have, you know, so all the variations, it could be the one index, but it could be Australian dollars, it could be US dollars, it could be in euros, it could be Indian. Now that's just five of listed of the same, essentially same index. 

Alec: [00:05:22] Wow. Yeah. Still 3 million.

Kanish: [00:05:25] Yeah, it's a lot. And that's only growing. And the ETF industry is. Turbocharge some of that growth because ETFs have made exposures in certain themes and sectors a lot more accessible. And so because of that, you then have more development in that index world. 

Bryce: [00:05:42] So you've got companies that create these indexes that you as an issuer, then track and create the ETF around that, around that index. So can you give us some examples then of who these index companies are? 

Kanish: [00:05:59] Sure. So some of the biggest ones and you know, if you watch the finance reports, you'll see the S&P, ASX 200 to S&P, Standard and Poor's, they're one of the largest index managers. Footsie MSCI, you've got Nasdaq. But then there's also newer index providers and index managers that have started coming to especially the ETF space. So they're companies like active and you know, at Global X, we use and track a lot of selective indexes. There's a company called I Index. So basically it's index, but sometimes it's easier to say index X because that's actually, you know, it's name. They're another index manager and they do a lot of work around thematics as well. So you then go down the path and there's companies like Morningstar as well. 

Bryce: [00:06:48] So it's these guys that are making the decision of what goes in the S&P 500, Standard & Poor's and making the decision of what goes in that index.

Kanish: [00:06:56] They essentially create the rules because remember, an index is defined by a rule book and those rule books are public. So if anyone actually wanted to, they could go and look at the rule book, the guidelines of any of the indexes that eight passive ETFs track. And so our job as a ETF issuer when we're developing an ETF is we speak with the index managers and we speak with all of them. And we will try to work out, depending upon what exposure we want to provide investors within that ETF to. We will speak with all the index managers and ask them, what do you do, What can you do in that space? Sometimes it's an off the shelf. It's already there. You know, it's been used by an ETF in the U.S. or, you know, they've developed that index. So it's got some history and we can go, okay, we can take that and we can use that straight away. Sometimes there is a bit of back and forth and, you know, we may say, well, you know, and that's in that product development stage where we take client feedback, etc.. 

Alec: [00:07:54] So let's take the ASX 200 index one that most people listening will likely have heard of. If they're not investing in it, they might have heard it on the 7:00 news or something. The two tracks, the 200 biggest companies in Australia. We could all do the work to figure out the 200 biggest companies in Australia and put them in order. Yep. So why do we need S&P? Why don't we just do it ourselves? Should we cut them out of it? 

Kanish: [00:08:23] I would say, Do you have the time to do that every day? 

Alec: [00:08:28] I got heaps of time.

Kanish: [00:08:31] Well then, yes. If you do, then theoretically you could do it yourself. So what I say that, you know, ETFs is such a transparent vehicle that we tell you as an ETF provider, you go into any of our products, especially the equity products, you can see the whole portfolio updated daily. The index managers give you that rule book. So yeah, theoretically anyone can take that and replicate it themselves. But what we're trying to do as an ETF issuer is make it easier and more cost efficient for you to do that. So if you were to say create that index yourself and track it and manage it, but then you have to trade it, you're trading 200 stocks. What happens when the index rebalances every quarter and there is some change of the weight. 

Alec: [00:09:17] But it isn't global X trading it well. 

Kanish: [00:09:19] That's what we do. So it's a way. 

Alec: [00:09:21] I'm not trying to cut you out. No, no, you can't do it. No. Okay, well, we'll look well, we'll do what we do. 

Kanish: [00:09:29] But I guess that's the whole concept is they are an independent party as well. So there's no ability for anyone like for us. We don't decide within our site in the robo ETF, we don't decide to buy, you know, Intuitive Surgical, which is a company that produces medical devices, and they do the robotic medical device, the machines versus say, cancer or cancer, which is a company that does sort of sensing and actuation, for example. So that's not our job. Our job is to track that index that we've worked with. That index managed to decide and choose, and we monitor that, by the way. So I'll give you an example. We work with the index manager. ACDC is a Battery Tech and Lithium ETF and will put on wrapping robo but Battery Tech and lithium within that index. We actually worked with the index manager, which is still active because we felt that there should have been an ESG screened in place. Okay. In that particular ETF. At the time when that index was developed eight years ago, seven years ago, that wasn't the case. And there may not have been a need for the industry of that thematic, may have been too small, so they didn't do it. Now, the feedback that we got from clients and from investors, we felt that that needed to be done. So we asked that question of the index manager, and then they run through a public consultation such as us deciding they go through a big public consultation, they go through a process, they've got an index committee. So there's a lot more nuance and structure and process within that index management than just one person. Having adopted and thrown in. Can I like Tesla today or do I like wide? You know, it's more than that. And so they actually implemented an ESG screen last year which then when it rebalanced our ETF. Replicated and tracked.

Bryce: [00:11:19] Well that does latest nicely to to ROBO or in full name global X is global robotics and automation ETF as you mentioned there can you know some index providers actually have pretty specialised knowledge in creating thematic ETFs and really giving us exposure to quite, I guess, niche megatrends or thematics or whatever it may be. And this is certainly the case with this ETF. So can you tell us about the index provider behind Robo and how this is actually brought to life?

Kanish: [00:11:50] Robo Global is a bit of a unique company, so it's not as well known as S&P or Footsie or NASDAQ or, you know, Bloomberg, for example. But it's quite specialised within this space and that's why we chose it for our robo ETF. So we wanted to provide investors exposure to the thematic of robotics, automation and artificial intelligence. Now, there is no sector classification for that theme. There is no industry classification, you know, So how do you do that? And that's where Robo Global came about. Essentially, Robo Global was founded by stock pickers. So people that the day job was to identify names and pick them and invest in them. And they brought together experts within the robotics, the automation, the A.I. fields to essentially create this company, to go let's redefine and let's define, not even redefine us defined what this thematic is and what the companies that are associated with this thematic, because it could be it's industry agnostic, it's sector agnostic, it's country agnostic. So it goes across many different areas. And I think that's really important. So it was started in the US and it's got a number of ETFs that track their indexes. They've got this particular index, which is the Robo Global Robotics and Automation Index. But the best thing about this company for me is it's as close to an active manager as you can get because they have a research team of five people, they've got a head of research, they've got analysts that these people are actively going out and speaking to companies to identify and work out what's their revenue priority. Other market leaders, are they doing innovation in this specific space, whether it's 3D printing, whether it's sensing, whether it's actuation, they're also working out what does that universe look like? So they've got an actual analysts and research team now because we're not actively changing the strategy every day. We don't have to charge active fees, which is why that's a benefit of the ETF would have created an index fund, which means you're buying the same you're not buying just one specific name. Now, that research team creates this universe that rules are then applied on that universe to create the ETF. But the best part about this is that research team is supported by what they call their strategic advisors. So Robo Global engaged with nine strategic advisors. So these are people across this field of robotics, automation from academia, entrepreneurs, etc.. Seven out of the nine I was looking at this the other day, seven out of the nine have PhDs. So you've got people like Dr. Henry Christiansen, so he's essentially Qualcomm. So Qualcomm, we know Qualcomm is one of the big semiconductors. He's the Qualcomm's chancellor's chair of Robot Systems. So he's essentially heavily involved within that space. You've got, you know, Raffaele de Andrea, he created and I think I've spoken about this before, but he's created Kiva Systems, which now is Amazon Robotics. So when you look at those logistical warehouses and the fulfilment centres and you see all these robots filling your boxes, when you order, when you order your Amazon, that's essentially. Raffaele has created that. 

Bryce: [00:15:07] So just to kind of tie this up before we go under the hood, you've got the big index providers, your Standard and Poor's, your Footsie, which is the Financial Times Stock Exchange, you've got MSCI, they're your big index providers. And then on the other end of the spectrum, you've got Robo Global who is still an index maker, index provider, but very specialised, very niche, bringing in all of these experts to create indexes that Global X and other ETF issuers can go out and create ETFs around. 

Kanish: [00:15:42] Exactly right. And so we used them because they were so targeted, so specialised, and we felt at the end of the day we want to provide best of breed products. And a lot of that product development process is founded on research and making sure that the product that we give is best of breed and actually does. You know, when you lift under the hood of that ETF, you can work out and identify that I'm buying an ETF that gives me exposure to that, the medical, robotics, automation and artificial intelligence. So we make sure we partner and license indexes that do that.

Alec: [00:16:11] Well, let's go under the hood and let's have a look at this particular ETF. So as always, when we're going under the hood, the place to start is the ETF issuer's website. So if all global X ETFs that's globalxetfs.com.au. Bryce, let's rip through the key information purpose index phase hit me.

Bryce: [00:16:37] Ready go hit some music purpose. This ETF seeks to invest in companies that, as Kanish said, potentially stand to benefit from increased adoption and utilisation of robotics and artificial intelligence. Pretty straightforward. It tracks, as we've just discussed, the Robo Global Robotics and Automation Index and has fees of 0.69%.

Alec: [00:17:00] So that's what it wants to do. How does it how much it costs to do? Now let's talk about performance, robotics and automation. official intelligence, buzzy parts of the market. 

Kanish: [00:17:13] Yes. So look, performance, if I put it in a one year perspective, given how volatile 2022 was, especially for particular sectors that Robo invested in, it performed and provided a return of 0.67%. So still positive.

Alec: [00:17:33] I think 2022 is a win. 

Kanish: [00:17:34] Yeah, well and it's funny because again, we associate robotics, automation and AI companies to be tech stocks. They're not always tech stocks. You know, you could have a company like John Deere sells tractors. Yeah, that's neat. That's an ETF. I love it because they have a lot of automated tractors that they sell. So it's not just tech companies that have been impacted by that sort of turn from growth to value last year in 2022. But over five years, this fund's returned 8.17% annualised per year. The index returned 8.76%. So the tracking difference, which is that difference between the fund and the benchmark, is 0.56%. So that's what we're aiming for. So that means that tells me that the US as an ETF issuer, we're doing our job with tracking the index. Implicitly, I should be doing better because that difference should just be the fee and it's actually less than that. 

Alec: [00:18:30] Yeah. Yeah. Nice. All right. Well, that's where we want to start when we go under the hood. And now we go to top Holdings. 

Bryce: [00:18:38] And guys, no surprise here. The United States at number one, 44%. Japan, though, coming in at 20%. 

Alec: [00:18:46] I wasn't surprised by that. Japan's the home of robots. 

Bryce: [00:18:49] It is. 

Kanish: [00:18:50] Automation. Factual.

Alec: [00:18:52] Yeah, yeah, yeah. I also wasn't surprised by the third, Germany and the industrial powerhouse of Europe. Not surprising there as well. So not a lot of surprises there. Anything that stands out.

Bryce: [00:19:02] The only thing is that it seems truly global. There's no, I guess, defining characteristic here between developed and emerging. It's just you're going to get exposure wherever the best companies are. Correct me if I'm wrong, Kanish.

Kanish: [00:19:13] Yes. So this index or this ETF also looks at developed markets plus Taiwan and Korea. So again, that's been a slight change rather than just going developed or broad. And the reasons for that is that was, you know, Taiwan and Korea are still very developed. And you can see that there's, you know, Taiwan being number four. 

Alec: [00:19:34] And China as well,. 

Kanish: [00:19:35] And China as well. No, but China, there is some exposure to two Chinese names as well. 

Alec: [00:19:42] At some point it feels like those classifications have to shift, like South Korea, like if come on. Anyway, that's not for us to decide. 

Kanish: [00:19:50] Which actually is why in a lot of our thematic ETFs, we actually include countries like Korea and Taiwan in particular, because we don't want to exclude them. You can't just won't one. 

Alec: [00:20:00] So the sectors, not surprisingly, pretty evenly split between information technology at 43% and industrials at 41%. Health care surprisingly comes in at 13%. And the biggest waiting in the ETF is a company that I really love talking about and is in the health care space. So we'll get to that in a second. And then a little bit in the consumer space, consumer discretionary and consumer staples. So no real surprises there. But let's get to the top holdings, because number one is one that I have heard of, number two. Number three, certainly not Intuitive Surgical make of The Da Vinci Machine. 

Kanish: [00:20:40] Exactly. I reference those that they make. Basically, Da Vinci machine is like a mid body robotic medical machine. So it allows surgeons and doctors to essentially run mid body operations, but through robotic arms, a very precise the precision is amazing. So there was a YouTube video of The Da Vinci machine peeling a grape and then stitching it back together, the skin of the grape. So that's how precise you can do it. And essentially, if you've got good enough Internet, that surgeon and doctor could be sitting across the World. And still running that surgery. 

Bryce: [00:21:11] God, you'd want good Internet.

Alec: [00:21:14] You wouldn't want to be in our studio right now. Bryce's entire body parts popping off his phone. You have to drop out at that critical point in time. But outside of Intuitive Surgical, a few names that I haven't come across. Keyence Corp, Bryce? 

Bryce: [00:21:34] No.

Alec: [00:21:34] Cognex Corp.? 

Bryce: [00:21:35] Something to do with cognitive stuff? 

Alec: [00:21:38] Yeah. All right. We might have to turn to conditions. 

Kanish: [00:21:41] So Keyence, they do automation, sensors, vision systems, barcode readers, etc. So think about within a factory some of the sensing that's required for an automated factory to operate know that's essentially what Keyence produces technology for. So when you think about robotics and automation and artificial intelligence, they essentially it's like they all work together. So it's like a trinity, essentially. And so you need everything to work together. So if you've got the factory that has the robots, that puts all the things together, you have to have the sensing equipment that actually does the work. After the software equipment, you have to have the actuation. So the parts that go into making that robot and then you have to have the software that can learn off itself, which is the AI. So it's all all encompassing, all intertwining. 

Bryce: [00:22:33] And what about Cognex, Kanish? 

Kanish: [00:22:35] So Cognex, essentially it provides vision products within that space of using sensing. So again, within the if you're going to have a lot of what you have is the companies that produce the parts to make and, you know, allow for automation to work. So that's your sensing software, your actuation, so semiconductors, etc.. But then you also have the other part, which is the actual application site. So Intuitive Surgical produces medical devices. John Deere produces tractors. So that's where you've got the two differences. 

Bryce: [00:23:11] Well, I think my key takeaway here is there's ten names, eight of which I haven't heard of, and I love that about AI investing coming across new companies. But this is a great example of having a specialised niche index maker who puts a lot of time and expertise into creating an index that can then turn into a great thematic ETF. So Ren to close out same question or for all of us, where does this fit in our portfolio? 

Alec: [00:23:37] Well, again, I think it's a long term trend, robotics and automation and AI certainly not going anywhere. So I'll be thinking about this long term because it's thematic. And Kanish said earlier, it's as close to a stock picking as you'll get in a passive ETF. For me, this is a satellite holding, but it's a compelling one. 

Bryce: [00:24:00] It is. 

Kanish: [00:24:01] It is essentially a satellite holding. So when people think megatrends are investing in thematics, you want it to be long term. You know, people can be tactical with those things. But my general view on that is it's a long term trend. Satellite, it complements, again, broad exposures. So we you know, in the first episode we talked about tech techs that global sector play complements broad global equity exposures. Your international allocations robo does the same thing. But for investors, this has to align to your views and values of how you see the domestic world operating as well. 

Bryce: [00:24:32] That brings us to the end of our third episode, and hopefully you've got another tool to add to your kit when it comes to analysing ETFs. We try to answer the question around what index are you tracking and how is it made? We know that it can either be made by some of the largest index track index companies in the world. The S&P is your Footsie, the MSCI, or on the other end, there are specialist index companies that make these niche thematic ETFs. You can find all of the information on the underlying index and the rules that they follow to create the index on all of the ETF information page is found on the website so you can find more information at globalxetfs.com.au, and a big thank you to global X for supporting the Under the Hood series. Global X are a leading player in the ETF industry with a robust platform and over 30 targeted products globally. They have a trusted reputation with over a million clients in 90. Five countries and are uniquely positioned to identify and analyse disruptive companies with their industry leading research team and global access. And we're lucky enough to have their expertise throughout these ten episodes. Kanish, thank you so much. Pleasure as always. And we've got you back on in a couple of episodes.