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The UK small cap ETF that’s too big for its boots

I was one happy passive investor when Credit Suisse launched their UK small cap ETF (ticker CUKS) on the London Stock Exchange last September.

It was the first UK small cap tracker: plugging a gap in the market that denied passive investors an important route to diversification, and the potential of enhanced returns. Or so it seemed.

Sadly, now I’ve looked into CUKS, it’s not my idea of what a UK small cap ETF should be. It’s actually closer to a pricey mid cap tracker, in my opinion.

It’s the law

One of the unbreakable rules of tracker-buying is to always check the index; making sure the fund you’re eyeballing adds the exposure your portfolio needs.

In the strange case of CUKS, the benchmark is the MSCI UK Small Cap index. But what’s actually in this?

It’s worth exploring, because there’s no commonly agreed size limit for a small cap company. You can end up with some fairly big beasts falling into your ‘small cap’ index, especially if your net’s mesh isn’t very fine.

And rival UK small cap indices have very different ideas about how close to the bottom of the market they’ll go when trawling for small caps:

  • The FTSE SmallCap Index captures roughly 2% of companies in the 98th and 99th percentiles of the UK market.
  • The RBS Hoare Govett Smaller Companies Index captures roughly the bottom 10% of the UK market.
  • The MSCI UK Small Cap Index captures roughly the bottom 14% of the UK market up to the 99th percentile.

The upshot is the MSCI index is doing a lot of fishing in the FTSE 250 layer of the market. What it defines as small cap, many UK investors think of as mid cap. And that could mean some major overlap if you’re already holding FTSE 250 funds.

CUKS mostly fishes for firms in the depths of the mid cap FTSE 250

What’s more, CUKS has a TER of 0.58% – more than double the 0.27% TER of HSBC’s mid cap FTSE 250 index fund (which can be bought sans trading fees).

So the key question is: how much small cap coverage am I getting from CUKS that I can’t get from a FTSE 250 tracker?

In my opinion, not enough.

X-Ray vision

Morningstar’s Instant X-Ray tool enables you to probe funds for overlap.

I compared CUKS with HSBC’s FTSE 250 index fund. Tellingly, Morningstar classifies both funds as mid cap. The detailed analysis of stocks held in the funds also revealed the following market cap breakdown:

Large cap Mid cap Small cap
CUKS TER 0.58% 0.92% 57.29% 41.79%
HSBC FTSE 250 TER 0.27% 4.9% 56.50% 38.59%

Morningstar Instant X-Ray analysis, January 8, 2011.

According to those stats, buying CUKS would gain me only a few extra percentage points of small cap stocks in my portfolio over a regular FTSE 250 index fund.

Yet I’d be paying more than double the TER plus trading fees for the privilege.

You can check the constituents of CUKS on Credit Suisse’s website. Go to Products > Equity > UK > CS ETF (IE) on MSCI UK Small Cap > Portfolio Structure. Most holdings are FTSE 250 firms. Fewer than a quarter are from the FTSE SmallCap or FTSE AIM All-Share, at the time of writing.

It looks like a poor deal in my book. I am prepared to pay a higher TER for a fund that tracks an index like the FTSE SmallCap. But I’m not paying well over the odds for a mid cap ETF with a small cap accent!

Take it steady,

The Accumulator

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{ 8 comments… add one }
  • 1 Alex January 11, 2011, 7:53 pm

    1. Hi TA. Thanks for a fantastic post.

    2. Like you, I’ve had my eye on CUKS since launch. Again, like you, that TER put me off – it’s just too high. Oh, and funnily enough, I hold the HSBC FTSE 250 tracker.

    3. So, it seems that CUKS doesn’t do ‘what it says on the tin’ – or at least not as well as it should. That’s very useful information.

    4. One thing that’s puzzled me about the Credit Suisse ETFs for us individual investors is that the company doesn’t seem to want to publicise them. Do you have any idea why? It all seems very low-key in the UK. Perhaps they are embarrassed at the TERs? They should be!

    5. For UK small-cap exposure, I’ve been looking at the db x-trackers ETF on MSCI EUROPE SMALL CAP TRN INDEX (Ticker: XXSC). The TER p.a. is more reasonable: 0.4%. As you’d expect, the UK is well represented in the index. In fact, the UK is just over a third of the index. Do you have any comments on XXSC?

    6. What I really want is: realistic accessibility to Vanguard’s index fund on Global Small-Cap Index. We can only hope…

  • 2 Mark Gibaud January 12, 2011, 12:08 am

    Wow! Good to know, thanks!

  • 3 Alex January 12, 2011, 3:31 pm

    1. Another thing: here there’s an implicit assumption which I think should be made explicit.

    2. We assume that Morningstar’s ‘Instant X-Ray’ provides meaningful results for both funds. If it doesn’t, then these results aren’t directly comparable.

    3. Also, we assume that its categories by cap size are useful for our purposes. Back to the issue then of how to define small-cap, etc.

  • 4 Frugal January 12, 2011, 7:09 pm

    Interesting read.

    What about the Gartmore Fledgling Trust (GMF.L – TER 1.2%) which tracks the FTSE fledgling index and seems to be the only one that does so? Its captures these small companies really well.

  • 5 Doctor Stock January 13, 2011, 3:48 am

    Interesting TA. Even tho most passive investing styles enjoy a little something extra on the side… and I don’t blame em
    .-= Doctor Stock on: Seasons of Investing =-.

  • 6 The Accumulator January 13, 2011, 8:05 pm

    @ Alex – XXSC is an interesting idea – the problem for me is threefold. One is that its MSCI Europe SC index uses the same methodology as the MSCI UK SC index, so the constituents are likely to be similar. A thorough look at the list of constituents would reveal whether this is actually the case.
    The second is that it’s a dollar fund so exposing me to currency risk I’d hope to avoid from a UK fund, and finally, even 1/3 invested in UK small caps it’s no substitute for a proper UK fund. Vanguard’s global small cap fund is about 8% UK.

    You’re right, we are partly relying on Morningstar to produce meaningful results, although a look at the CUKS constituents will tell you that it’s mostly invested in the FTSE 250. There’s even a few FTSE 100 firms in there. However, Morningstar’s definitions of small cap are less important than it’s revelation of how closely CUKS mirrors a FTSE 250 tracker.

    @ Frugal – You’re right to point out Gartmore as an option. It’s a hybrid passive/active fund, and obviously pricey for me as a passive investor.

  • 7 The Compounder December 23, 2013, 11:31 pm

    I’ve had the same problems, so I just stick with expensive investment trusts such as AGIT and SDV, primarily. Perhaps the ETFs don’t suit small caps due to liquidity risk?

  • 8 The Accumulator December 31, 2013, 12:18 am

    Interesting, I will take a look at those two, Compounder. I use ASL, it’s small value and not too expensive. Nice name btw.

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