Dynamic Correlation between Share Returns, NAV Variation and Market Proxy of Brazilian ETFs

Abstract

Exchanged Traded Funds (ETFs) have become one of the largest investment opportunities today. They present special features that differentiate them from other investment funds, in which the most important are their traded shares. Their share prices are market oriented and are not necessarily strongly correlated with the value of their portfolio, i.e, their Net Asset Value (NAV). Then, the relationship between share return, net asset value variation and market return goes beyond the understanding of traditional models, like CAPM, puzzling investors. Hence, the objective of this paper is to analyze the dynamics of share return and NAV variation of Brazilian ETFs and how they behave in relation to the Brazilian Market. We use the Dynamic Conditional Correlation of Engle (2002) to analyze these dynamics. Our results point that the correlation between Share and Market returns were higher that the correlation between NAV variation and Market return, indicating that an investor who buys ETF share is more exposed to Market risk than the risk of the ETF fund portfolio. Another important issue regarding the crisis periods is that the DCC between Share and Market return showed that before the subprime crisis, there was a correlation drop, indicating that ETF market suffers some kind of effect that could be a crisis forecast. But during the Euro zone debt crisis, the correlation drop happened concomitantly with the volatility increment, i.e., with the crisis. That can be because of different natures of the crises, since the former was a financial crisis and the latter an economic crisis. We also find that when not in a financial crisis period, the ETF’s returns are more linked with the overall market, but during financial crisis periods, investors seek to trade ETF shares by their NAV value. During the economic crisis, however, the opposite effect seems to occur: the correlation between Share and Market return remains higher than 0.95, but the correlation between Share return and NAV variation drops to very low standards. DOI: http://dx.doi.org/10.5755/j01.ee.25.1.4274