Equity Exchange-traded Funds Research Articles

Active vs. Smart Beta ETFs: Two Sides of Active Management

This article examines the characteristics and performance of active and smart beta equity exchange traded funds (ETFs) listed in the United States since 2000. Using a sample of 95 active equity ETFs and 376 smart beta equity ETFs, the author found that as of October 30, 2020, only 20% of active equity ETFs and 15% of smart beta equity ETFs performed better (in regard to return) than the S&amp;P500 index (market) during the past five-year period. Using Fama–French–Carhart six-factor return attribution analysis, the author finds that more than 20% of smart beta equity ETFs and 10% of active equity ETFs have significant alpha at the 10% level of confidence after controlling for all Fama–French–Carhart factor returns. The excess market return factor is significant in all variants of return attribution analysis. All return attribution analyses reveal that the value investment category and the small-cap size category of both active and smart beta equity ETFs have 100% exposure to respective factor returns. There is significant scope for active and smart beta equity ETF fund managers to enhance the security selection process and create a better factor tilting strategy, respectively. <b>TOPICS:</b>Exchange-traded funds and applications, factor-based models, statistical methods, performance measurement <b>Key Findings</b> ▪ Twenty percent of smart beta equity exchange traded funds (ETFs) and 10% of active equity ETFs have significant alpha at the 10% level of confidence after controlling for all Fama–French–Carhart factor returns. The excess market return factor is significant in all variants of return attribution analysis. ▪ Fund managers of smart beta equity ETFs need to create a better factor tilted strategy to gain maximum exposure to intended factors. ▪ Fund managers of active equity ETFs should focus on a better security selection process to maximize alpha, that is, minimize market and other known factor exposures.

Impact of ETF Listing on the Returns Generated by Underlying Stocks: Indian Evidence

The advent of exchange traded funds (ETFs) has rendered index trading much affordable compared to their futures counterparts. The present study attempts to examine the impact of ETF listing on the price of the constituent securities of the index that it aims to track. The sample comprises of all the equity ETFs listed in India from 1 January 2002 to 31 March 2019. Event study analysis has been used to examine whether listing of ETFs bore any price impact on the constituent stocks of ETFs. To account for robustness, both parametric and non-parametric tests have been employed. The estimates obtained from event study analysis revealed that the constituent stocks generated insignificant returns for the period extending from January 2002 to March 2009 and April 2009 to March 2013 but positive and significant cumulative average abnormal returns (CAARs) post ETF listing for the period ranging from April 2013 to March 2019, thus providing evidence in support of positive price impact. The permission granted to pension funds, insurers and Employees’ Provident Fund Organisation (EPFO) to invest their funds in ETFs as well as reduction in Securities Transaction Tax (STT) account for the observed price differential. An analysis of the factors accounting for the variation in valuation effects ascertained that the stocks that were traded thinly prior to ETF listing and those forming part of ETFs with larger asset base experienced positive price impact following ETF listing. JEL Codes: G11, G14

The Performance of Exchange-Traded Funds

Exchange-traded funds (ETFs) are commonly regarded as an efficient, low-cost alternative to actively managed mutual funds, yet their perceived superiority is largely anecdotal. We evaluate the performance of a comprehensive, survivorship-bias-free sample of US equity ETFs following the approach that has been commonly used to evaluate the performance of actively managed mutual funds. We find that ETFs have collectively lagged the market by an amount similar to the widely documented underperformance of active mutual funds. We perform textual and regression-based analysis to identify factor ETFs and show that most of these have also failed to beat the market. We conclude that, from a pure performance perspective, the allure of ETFs finds little support in the data. TOPICS:Factor-based models, mutual fund performance, passive strategies, exchange-traded funds and applications Key Findings ▪ ETFs have collectively lagged the market by about the same amount as active mutual funds. ▪ Most smart beta ETFs have also failed to beat the market. ▪ From a pure performance perspective, the allure of ETFs finds little support in the data.

(Sub)Optimal Asset Allocation to ETFs

We study the allocation of capital to U.S. equity exchange-traded funds (ETFs). Investors tend to invest more in ETFs with lower fees and higher liquidity, consistent with common intuition. We also find, however, that investors make substantial allocations to ETFs that are similar to existing ETFs while incurring the costs of higher fees and lower liquidity. We estimate the aggregate cost to ETF investors from investing in dominated funds to be $1.1 billion to $17.5 billion since 2000 depending on the bench-marking approach. We conclude that ETF investors may be better off, as a whole, by concentrating on a relatively small set of low-fee, high-liquidity funds.

Relative efficiency of equity ETFs: an adaptive market hypothesis perspective

ABSTRACT In light of the growing prominence of passive investment schemes in general and Exchange Traded Funds (ETFs) in particular, this study examines the relative efficiency of domestic equity index ETFs across the globe from an Adaptive Market Hypothesis perspective. To be specific, we examine the relative efficiency of equity ETFs pertaining to Australia, Canada, China, Eurozone, France, Germany, India, Japan, UK and USA. We do so by employing rolling estimations of inherent long memory in these financial time series. Our findings indicate the presence of episodic long memory or anti-persistence in the first and second moments of these ETFs and their underlying indices. Put differently, the efficiency of ETFs and their underlying indices were found to be dynamic in nature. While our findings lend credence to Adaptive Market Hypothesis, they also (a) pinpoint the need for policy prescriptions geared towards diversifying investor base, and (b) call into question the past assertions that markets are becoming more efficient over time.

Do ETF flows increase market efficiency? Evidence from China

AbstractFocusing on the equity exchange traded funds (ETFs) in China, we demonstrate the significant effect of ETF flows on the informativeness of the ETF index. Following the novel approach proposed by Xu et al (2019a). to identify different driving forces for ETF flows, we explore whether the forward‐looking ETF flows at a day’s closing substantially improve the index’s efficiency on the next day. The mechanism behind it is inter‐market information spread: the efficiency effect of the forward‐looking ETF flows strengthens when ETFs share more new information; and the forward‐looking ETF flows increase the information flow to the ETF index on the next day.

Pricing Efficiency of Exchange Traded Funds in India

Exchange traded funds (ETFs) have two prices, the market price and the net asset value (NAV) price. ETFs NAV price gets determined by the net value of the constituent assets, whereas the market price of ETFs depends upon the number of units bought or sold on the stock exchange during trading hours. As per the law of one price, the NAV and market price of the ETF should be the same. However, due to demand and supply forces, the market price may divert from its NAV. This price difference may have significant repercussions to investors, as it represents a cost if they buy overvalued ETF shares or sell undervalued ETF shares. Pricing efficiency is the speed at which the market makers correct the deviations between ETFs NAV and market price. The present study attempts to investigate the pricing efficiency of Indian equity ETFs employing an autoregression model over its price deviation, and also attempts to understand the lead-lag relationship between the price and NAV using the vector error correction model (VECM).

Bank of Japan as a Contrarian Stock Investor: Large-Scale ETF Purchases

The Bank of Japan (BOJ) started to purchase equity exchange-traded funds (ETFs) in 2010 and doubled its annual target amount in 2020 during COVID-19 to decrease equity risk premia as part of its unconventional monetary policy. This study demonstrates that the BOJ times the market by buying ETFs after observing negative overnight and morning stock returns and stopping purchase after seeing positive overnight and morning returns. Lunchtime returns are higher on the day of the actual ETF purchase, especially during the COVID-19 pandemic, suggesting that the program takes effect through the scarcity channel. Although the announcement of the doubled budget did not have an immediate effect on stock prices, we observe consistent increases in stock prices and decreases in volatility after the announcement. The BOJ’s commitment to counter-cyclical ETF purchase may have contributed to a lower equity risk premium by providing investors with downside protection.

Can Expense Ratios Signal Performance? An Analysis of Equity ETFs &amp; Mutual Funds

This study examines the impact of the emergence of exchange-traded funds (ETFs) as an alternative investment vehicle to mutual funds. As the number of ETFs continues to rise, we investigate potential risks and disadvantages posed by ETFs in comparison to traditional mutual funds. ­We compare the returns, performance, and expense ratios of ETFs to those of mutual funds. We find that expense ratios are positively correlated with actively managed mutual fund returns and that passive funds have outperformed active funds since their inception. There is downward pressure on mutual fund fees over time, suggesting increased competition between mutual funds and ETFs. We also find, up to a certain threshold, actively managed funds are worth their costs. KEYWORDS: Exchange-Traded Fund (ETF); Mutual Fund; Investing; Fee Structure; Expense Ratio; Passive (Active) Investing; Portfolio Management; Indexing

The price of international equity ETFs: The role of relative liquidity

We examine the effect of the relative liquidity of international equity exchange-traded funds (ETFs) and their constituent portfolios on the price difference between the fund’s market prices and its net asset values. We use data for a sample of 584 international equity ETFs listed in the U.S. over the period January 2012 to December 2017 and find that higher liquidity is associated with a lower absolute value of the ETF premium/discount. We document a positive relationship between liquidity and the price convergence of the ETFs and their underlying shares. The effect of liquidity on convergence is stronger for ETFs with high holding costs.

A study on volatility and return spillover of exchange-traded funds and their benchmark indices in India

PurposeThe purpose of this paper is to empirically examine the volatility and return spillover between exchange-traded funds (ETFs) and their respective benchmark indices in India. The paper uses time series data which consist of equity ETF and respective index returns.Design/methodology/approachThe study uses autoregressive moving average–generalized autoregressive conditional heteroscedasticity and autoregressive moving average–exponential generalized autoregressive conditional heteroscedasticity models. The study uses data from the inception date of each ETF to December 2016.FindingsThe findings of the paper confirm that there is unidirectional return spillover from the benchmark index to ETF returns in most of the ETFs. Furthermore, ETF and benchmark index return have volatility persistence and show the presence of asymmetric volatility wherein a negative news has more influence on volatility compared to a positive news. Finally, unlike unidirectional return spillover, there is a bidirectional volatility spillover between ETF and benchmark index return.Practical implicationsThe study has several practical implications for investors and regulators. A positive daily mean return over a fairly long period of time indicates that the passive equity ETFs can be a viable long-term investment option for ordinary investors. A bidirectional volatility spillover between the ETFs and benchmark index returns calls for the attention of the market regulators to examine the reasons for the same.Originality/valueETFs have seen fast growth in the Indian market in recent years. The present study considers the longest period data possible.

The Performance of Exchange-Traded Funds

Exchange-traded funds (ETFs) are commonly regarded as an efficient, low-cost alternative to actively managed mutual funds, yet their perceived superiority is largely anecdotal. We evaluate the performance of a comprehensive, survivorship bias-free sample of US equity ETFs following the same approach that has been commonly used to evaluate the performance of actively managed mutual funds. We find that ETFs have collectively lagged the market by an amount that appears similar to the widely documented underperformance of active mutual funds. We perform textual and regression-based analysis to identify factor ETFs and show that most of these have also failed to beat the market. We conclude that, from a pure performance perspective, the allure of ETFs finds little support in the data.

European ETF Factor Exposures: Evidence from a Regression- and Holdings-Based Analysis

The article analyzes factor exposures of European equity exchange-traded funds (ETFs) according to 10-year regressions and a holdings-based analysis. While smart beta ETFs target certain factors explicitly, they and conventional market-capitalization-weighted ETFs (conventional ETFs) both can carry implicit exposures, too. The analysis shows that especially various sector ETFs carry strong regression-based factor exposures, which are only partially mirrored from a holdings-based view. Collectively, the conventional and smart beta ETFs show various significant factor loadings, which are mostly backed by the holdings-based analysis. Translating the flows in smart beta ETFs into a form of factor timing of market participants, the asset-weighted smart beta aggregate outperformed the market on an absolute and risk-adjusted basis. TOPICS:Analysis of individual factors/risk premia, exchange-traded funds and applications, developed markets, performance measurement

Do exchange‐traded fund flows increase the volatility of the underlying index? Evidence from the emerging market in China

AbstractStudying 70 Chinese equity exchange‐traded funds (ETFs), we show that daily ETF flows significantly increase both the total volatility and the fundamental volatility of the underlying index on the next trading day. More specifically, it is the forward‐looking flow component which captures APs’ share creation/redemption activities beyond their role of market makers that can significantly predict the two types of volatility. Moreover, ETF arbitrage (ETF's information share) enhances the effect of forward‐looking flows on the total volatility (fundamental volatility) of the index. Furthermore, the relationships between forward‐looking flows and the two types of index volatility show a two‐way contagion.

Diversification benefits of Shari'ah compliant equity ETFs in emerging markets

Previous studies on the performance of Islamic finance and banking have been more comparative than experimental when it comes to the role and effect of Islamic (Shari'ah compliant) assets in a conventional setting. This paper investigates whether Shari'ah compliant exchange-traded funds (ETFs) have potential diversification benefits to a volatile portfolio of conventional investments in emerging markets. The results suggest that such assets not only improve the risk-adjusted returns of portfolios but also receive proportionally higher weight during crisis periods. Hence, institutional investors should consider the ‘religion effect’ when they manage their assets, given the evidence regarding the outperformance of Shari'ah compliant equity relative to their conventional peers.

Persistence of Volatility Spillovers in Indian Equity Exchange Traded Funds

Persistence of Volatility Spillovers in Indian Equity Exchange Traded Funds

Tracing financial innovation diffusion and substitution trajectories. Recent evidence on exchange-traded funds in Japan and South Korea

Since the rapid growth of the popularity of ETFs, the potential substitution between innovative financial products, exchange-traded funds (ETFs), and traditional investment funds (open-end and closed-end funds) is recognized as one of the most-discussed issues in the financial industry. This is the first study to empirically verify and compare the diffusion and substitution of ETFs using monthly data on their assets in two selected countries. The main aim of this paper is to provide in-depth insights into the development of innovative financial products available in two Asian economies: Japan and South Korea. The empirical study uses monthly total net assets data for 2004–2017. Our methodological framework combines models of innovation diffusion and technological substitution. The results reported in the study show that in both countries the diffusion of ETFs has occurred. The rate of diffusion and the phase of growth reached differed – in Japan the ETF market was in the early exponential growth stage, whereas in South Korea it was closer to achieving the expected maximum saturation. The results of the substitution analysis between the largest category of the innovative funds – equity ETFs and equity open-end funds clearly demonstrate that the process of “switching” from equity open-end funds into ETFs may be easily traced in both countries. Substitution processes were, however, gradual and reversals of the trajectories were noticed.

An empirical examination of the diversification benefits of U.K. international equity closed-end funds

I use the Bayesian approach of Wang (1998) to examine the diversification benefits of international equity U.K. closed-end funds (CEF) in the presence of market frictions. No short selling constraints substantially reduce, and in some cases eliminate the diversification benefits of CEF. However, adjusting for higher trading costs in the benchmark assets, the diversification benefits of the funds are significant. The paper also finds that when comparing to the international equity exchange-traded funds (ETF), that both groups of funds are necessary to maximize the benefits of international diversification.

Performance and Tracking Efficiency of Exchange Traded Funds : An Analysis of Indian Equity Index Funds

This research, using daily closing values of five leading Nifty exchange traded funds (ETFs), sought empirical evidence for the efficiency of equity ETFs in India to track their benchmark index. The study computed 'standard deviation of differential returns' and 'standard error in regressing the fund return against the Nifty return' to assess the tracking efficiency of funds. The analysis found underperformance of Nifty ETFs relative to their benchmark index coupled with higher level of tracking errors during market downturns. In contrast, I found significant improvement in tracking ability and most funds outperformed the benchmark with lower tracking errors under reverse market conditions. The research ultimately suggested that preferring ETFs to index portfolio investing offered greater opportunities for arbitrage to the investors of emerging markets like India, particularly during the times of market buoyancy.

Determinants of price discovery in the VIX futures market

Abstract We utilize the respective information share and common factor component weight approaches of Hasbrouck (1995) and Gonzalo and Granger (1995) to examine price discovery competition between the VIX and VIX futures. Our results show that VIX futures prices play a dominant role in the overall process of price discovery. An increase in the price difference between the VIX and VIX futures, commonly referred to as the futures basis, causes a corresponding increase in the contribution to price discovery made by VIX futures. Our empirical results also show that news announcements on macro-economic issues in the United States increase the dominant role of VIX futures in the overall process of price discovery. This dominant role remains unchanged when compared to VIX exchange-traded products and the volatility indices on non-US equity exchange-traded funds.