Editor’s note: This is general educational information about how screened and thematic exchange-traded funds are constructed, not investment advice, and it does not assess any fund. It is based on the official documents listed at the end.
Analysis: two different clocks, one portfolio
The odd holdings that draw complaints usually come from the gap between these layers rather than from a mistake in either. The index layer moves on a published calendar: semi-annual liquidity testing in March and September, quarterly review deletions, and methodology changes routed through an approval board and, for significant ones, a market consultation. The fund layer moves on registrar determinations and deed amendments that require a majority in value of investors. Neither clock is set by the news.
The consultation requirement is the part most readers underestimate. Because significant methodology changes that could alter an index’s composition may be put to wider consultation, and because the external advisory committees then assess the responses, a theme definition is harder to tighten than to write. That asymmetry favours stability of the rule over precision of the label, which is the mechanism behind a fund holding a company that no longer fits the story its name tells.
What this structure establishes is process integrity. There is an approval trail for the methodology, a documented screen for each security, a registrar-set boundary on what may be held, and a deed that cannot be amended around investors. What it does not establish is thematic purity. Nothing in the ground rules or in the Act requires a fund’s holdings to match a plain-language reading of its name, and the free float and liquidity screens will exclude some of the purest expressions of a theme precisely because they are small or thinly traded.
The documents that settle the question are therefore the index ground rules and the fund’s deed, not the fact sheet. A reader wanting to know why a holding is present should look for the screen it passed, the review date on which it entered, and whether the registrar’s limits or the deed’s stated objects would have permitted anything else.
What the documents say
A fund’s name is marketing. Its holdings are the output of two rulebooks that have nothing to do with each other. One is an index methodology, written and approved by an index administrator under a governance process built for benchmark regulation. The other is South African collective investment scheme law, which fixes what a portfolio may hold and how the document that binds the manager can be changed. A holding that looks wrong for the theme is usually correct under both.
The index rulebook comes first, and it is approved before it is used
For an index-tracking fund, the security selection happens before the fund exists. FTSE Russell’s governance framework describes the sequence. Methodologies for all new benchmarks and indices are approved by the Index Governance Board to ensure they meet appropriate technical standards before launch or release to clients, and the same board approves changes to the methodologies of existing indices where these are proposed as a result of suggestions from external advisory committee members, staff, oversight committees or the results of market consultations.
Two internal bodies test a proposed methodology before it reaches that board. Operational forums assess whether the proposed index can actually be maintained, bringing together the people who would run it day to day and those who would conduct its reviews or reconstitutions, and they may suggest alternative approaches where implementation is not feasible. Methodology forums check that the documentation, including ground rules, calculation guides and pricing guides, is clear and unambiguous so that implementation matches what index users expect.
External advisory committees sit alongside that process, staffed by independent experts drawn from asset managers, asset owners and consultants. They are consulted on prospective methodology changes, and for significant changes with the potential to alter an index’s composition they may recommend a wider market consultation, then give feedback on how the consultation is constructed and on the responses. The whole structure is operated against the IOSCO Principles for Financial Benchmarks and the European and United Kingdom benchmark regulations, with FTSE International Limited authorised by the Financial Conduct Authority and FTSE EU SAS authorised by the Autorité des Marchés Financiers and supervised by the European Securities and Markets Authority.
The screens that run before any theme is applied
Theme rules sit on top of general eligibility screens, not instead of them. The FTSE Global Equity Index Series ground rules require eligible securities to pass a set of tests before entering an index at all. Constituents are adjusted for free float and foreign ownership limits, and securities with a free float of 5% or below are excluded outright. Liquidity is tested semi-annually, in March and September, by calculating each security’s monthly median of daily trading volume. Securities in certain surveillance segments are ineligible, and an existing constituent moved into one is normally deleted at the next quarterly review, then treated as a new issue once it is no longer under surveillance.
Depositary receipts illustrate how mechanical the screening is. A depositary receipt will be considered for inclusion only if the underlying share fails the liquidity test and the receipt passes it in its own right, and where a company has only receipts listed, the receipt is not eligible. Stapled units that combine an eligible security with a non-eligible one are not eligible at all.
Multiple share lines complicate the arithmetic in ways the rules address explicitly. The ground rules give the example of a company with 100m listed class A shares each carrying one vote and a free float of 65%, alongside other lines, precisely because free float and voting rights are calculated line by line rather than at company level. A company can therefore fail a screen on one line and pass on another.
The South African fund layer
Once an index exists, a local fund tracking it is governed by the Collective Investment Schemes Control Act, No. 45 of 2002, published on 13 December 2002. The Act puts the registrar, not the manager, in control of what is investable. Section 40 provides that the registrar may determine the securities or classes of securities that may be included in a portfolio of a collective investment scheme in securities. Section 46 allows the registrar, after consultation with the advisory committee, to determine the manner in which and the limits and conditions subject to which those securities may be included, and to set different limits for different securities, classes or portfolios.
Foreign holdings have their own gate. Under section 45, a manager may invest portfolio assets in foreign equity securities only where they trade on an exchange granted full membership of the World Federation of Exchanges, or on an exchange to which the manager has applied due diligence guidelines determined by the registrar. Foreign non-equity securities require an issuer in a country with a foreign currency sovereign rating, a long-term issuer credit rating on the international scale from a rating agency determined by the registrar, and the lower rating applies where more than one agency has rated the country or issuer.
The binding document is the deed between the manager and the trustee or custodian. Section 97 requires every deed to set out the requirements for administering a portfolio and to cover the matters detailed in Schedule 1 for securities schemes. Section 98 makes any provision inconsistent with the Act void, and allows amendment by supplemental deed only with the consent of a majority in value of investors, unless the registrar directs that consent be dispensed with because the amendment merely gives effect to the Act or the deed more conveniently, benefits investors, does not prejudice their interests, does not amend the fundamental provisions or objects of the deed, and does not release the trustee, custodian or manager from responsibility to investors.
Administration is licensed. Only a registered manager and its authorised agent may administer a collective investment scheme in securities, a manager must hold capital and reserves determined under section 88, and contravening the restriction is an offence carrying a fine or imprisonment for up to five years, or both.
