Chapter I INTRODUCTION
In the past few decennaries many public presentation rating surveies indicated that actively managed common financess, which seek to obtain extra returns than the market by actively calculating returns on single stocks, do non really obtain statistically important extra returns ( Jensen, 1968 ; Grinblatt and Titman, 1989 ; Elton et al. , 1993 ; Malkiel, 1995 ; Gruber, 1996 ; Carhart, 1997 ; Edelen, 1999 ) . This was consistent with the ‘Efficient Market Hypothesis’ which suggests that due to the handiness of all sorts of information, obtaining extra returns should be hard in a competitory market. These researches suggested a superior investing scheme: the index fund. Alternatively of actively prosecuting in stock picking, an index fund passively replicates the hazards and returns of an underlying market index by puting in the securities representing the index in the same weightage as represented in the index.
Since the first index fund launched in early 1970s, investors all over the universe have discovered that there are significant benefits from using index financess as an option to actively pull off financess. Some such benefits of indexing includes lower direction disbursal ratio ( due to inactive direction of fund ) , lower turnover and its related disbursals due to purchase and keep nature of most index financess and revenue enhancement efficiency when compared to actively pull off financess.
Like any other common fund, index financess may be structured as either open-ended financess or close-ended financess. Open-ended financess, as the name suggests, are unfastened for subscription and salvation for all the investors throughout the twelvemonth. However, one of the restrictions of such financess is that they are priced merely one time a twenty-four hours, after the stopping point of concern. Since all the trades in such financess during the concern twenty-four hours are executed at the shutting Net Asset Value ( NAV ) , investors are unable to respond efficiently to dramatic alterations in a market during the concern twenty-four hours.
Close-ended financess on the other manus, are unfastened for subscription merely one time, and can be redeemed merely on the fixed day of the month of salvation. Furthermore, in order to supply liquidness to such financess, these are listed on stock exchanges ( like corporate security ) and traded throughout the concern twenty-four hours on existent clip footing. Though the uninterrupted trading of such financess overcome the pricing restriction of open-ended financess, but at the same clip besides raises the issue of divergence between the trading monetary value and NAV of such financess. Since the overall principal of close-ended financess remain changeless, the day-to-day demand and supply forces frequently leads to important premiums or price reductions on such financess in the secondary market which is popularly known as closed-end fund mystifier [ 1 ] .
Acknowledging both the entreaties of open-ended index financess ( uninterrupted creative activity and salvation of fund units ) every bit good as of close-ended index financess ( uninterrupted trading on exchange like a stock ) , an advanced fiscal merchandise named Exchange Traded Fund ( ETF ) was designed in the early 1990s, which combines the good characteristics of both these types of financess.
The survey entitled “Cross-Country Analysis of Exchange Traded Fundss: A Study of Performance and Trading Characteristics” aims at analyzing this comparatively new fiscal merchandise available to investors, viz. , Exchange Traded Funds ( ETFs ) .
The intent of this chapter is to show the principle, aims, testable hypothesis, methodological analysis and the organisation of the survey. Towards this intent, the chapter is divided in six subdivisions. Section I is introductory in nature, which briefly describes the nature, beginning and growing of Exchange Traded Funds. Section II points out the spread in the bing literature on ETFs and elaborates upon the principle of the present survey. The specification of the aims of the survey is provided in Section III. Section IV contains the testable hypotheses of the survey. The research methodological analysis adopted, informations set and the clip period covered under the survey are described in Section V. Finally, Section VI provides the chapter-wise layout of the survey.
1.1 Exchange TRADED Fundss
Exchange Traded Funds ( ETFs ) represent a security that tracks a stock index, a trade good or a basket of assets like an index fund, but trades like a stock on an exchange. They are intercrossed investing instruments which combine the good features of a corporate stock and an index common fund.Like an index fund, they provide investors with the benefit of variegation through one investing merchandise, improved revenue enhancement efficiency relation to active portfolio direction, lower disbursals and transparence of portfolio. And like a stock, they can be transacted in little measures, can be short sold or bought on border and are priced and traded continuously on a stock exchange throughout the trading twenty-four hours.
All these characteristics of ETF rely on its specific double trading system, characterized by a primary market unfastened to authorised participants ( chiefly institutional investors ) for the ‘in-kind’ creative activity and salvation of ETF portions in tonss straight from the fund, and a secondary market unfastened to all investors, where ETF portions can be traded on existent clip footing, with no restriction on order size.
Since an ETF is negotiated on two markets, it has two monetary values: the Net Asset Value ( NAV ) of the portions on the footing of which creative activity and salvation takes topographic point in the primary market and the monetary value in the secondary market which depends on the supply and demand for ETF portions on the exchange. If purchasing or selling force per unit area is high, these two monetary values may divert from one another. However, the possibility of ‘in-kind’ creative activity and salvation facilitates an arbitrage mechanism which ensures that such goings are non excessively big. For illustration, if ETF portions begin to merchandise at a monetary value below the NAV ( i.e. at price reduction ) , arbitrageurs may buy ETF portions in secondary market and after roll uping adequate portions to be a creative activity unit, redeem the portions from the fund and thereby get the underlying securities in the index, which the arbitrageur may so neutralize at a net income. A similar and rearward procedure may use in instance of ETF trading at a premium. An effectual executing of this arbitrage mechanism would therefore enable the ETFs to merchandise at monetary values equal to or really near to their NAVs, thereby extinguishing the job of important premiums or price reductions frequently associated with closed-end common financess.
These advanced fiscal merchandises were foremost introduced on the U.S. and Canadian exchanges in the early 90s. Officially, the Standard and Poor’s Depository Receipts ( SPDRs ) is considered to be the first ETF which was created in 1993 in order to retroflex the public presentation of S & A ; P 500 Index. In the first several old ages, ETFs represented a little fraction of the assets under direction in index financess. However the launching of an ETF named regular hexahedron ( or QQQ ) in 1999 which follows the return of NASDAQ 100 Index was accompanied by a dramatic growing in trading volume, doing ETFs the most actively traded equity securities on the U.S. stock exchanges.
While ETFs were deriving popularity in the U.S, European stock exchanges started naming their first ETFs in 2000. Following the same tendency as the one observed in the U.S. , exchanges began by citing broad-based national and regional equity index ETFs. They so rapidly diversified the benchmarks to a assortment of implicit in indices. This included ETFs based on Euro zone or European indices, emerging state indices, manner ( socially responsible, growing, value, little caps, mid caps, etc. ) or sectors indices. Besides these equity-based ETFs, patrons launched fixed-income ETFs, ETFs based on cherished metals and in conclusion, on trade goods. Similar growing was experienced by ETFs in other planetary markets every bit good, including the Asia Pacific and Latin American markets which started naming these instruments in the early 2000s.
The popularity of these advanced constructions around the Earth can be gauged from the fact that at the terminal of March 2012, there were over 3,169 ETFs, with 6,795 listings, holding assets of $ 1,536.7 billion, managed by 157 suppliers around the Earth [ 2 ] .
- RATIONALE OF THE STUDY
A big figure of public presentation rating surveies have been undertaken for actively managed financess ( Elton et al. 1993, Malkiel 1995, Gruber 1996, Elton et al 1996, Carhart 1997 ) . However, despite the important growing in the value of assets under ETFs across the Earth, empirical research measuring the public presentation of this passively managed fund is rather limited. Furthermore, these surveies have concentrated on the U.S markets, with merely a few of them concentrating on the European, Australian or Asiatic markets. Besides, these researches done on assorted states have at times used different methodological analysiss for measuring the ETF public presentation and no empirical survey has yet compared the ETF public presentation across states utilizing unvarying public presentation standard.
The limited grounds on the public presentation of ETFs internationally, and the absence of empirical research comparing such public presentation across states provides the principle and motive for the present survey.This survey will lend to the literature by supplying analysis of the public presentation and trading features of ETFs tracking popular market indices across the Earth and supplying a comparing between them based on unvarying public presentation standard.
The work will be of direct utility to the investors in these markets, as it would assist in measuring the extent to which ETFs deliver on their promise of precisely tracking the index. From the position of market shapers, this work will assist in measuring the pricing efficiency of ETFs in these markets, which would perchance bespeak the presence or absence of profitable arbitrage chances in these markets. Besides, a comparing of ETFs across the Earth can supply utile indicants to the regulators and policy shapers of these markets sing the fight of their merchandises and the countries of strength and failings so as to be after for any disciplinary policy actions in regard of their markets, if required.
- OBJECTIVES OF THE STUDY
The first aim of the survey is to through empirical observation analyze the public presentation of Exchange Traded Funds ( ETFs ) across the Earth. To analyze the public presentation of ETFs, the survey analyses them in footings of their hazards and returns, reproduction scheme, tracking ability and public presentation effectivity.
The 2nd aim of the survey is to supply a comparing of public presentation of ETFs across assorted states.
Finally, the 3rd major country that this survey addresses to is the scrutiny and comparing of pricing efficiency of ETFs across the Earth, i.e. whether important premiums or price reductions exist in these ETF markets, and whether they persist over a figure of yearss, which could show profitable arbitrage chances to the market shapers.
- Research HYPOTHESES
The survey efforts to prove the following wide hypotheses refering the public presentation and pricing efficiency of Exchange Traded Funds ( ETFs ) across the Earth. The specific nothing and surrogate hypotheses are formulated in Chapter IV- Data and Research Methodology.
- Exchange traded funds are able to absolutely track the day-to-day and hebdomadal returns of their implicit in indices and experience insignificant tracking mistakes.
- Exchange traded funds are effectual in retroflexing the returns of their implicit in indices, and do non see important net under-performance or out-performance over half annual intervals.
- All ETFs across the Earth experience similar trailing mistakes ( if any ) , and are every bit effectual in their public presentation.
- Exchange traded fund markets around the universe are efficient in footings of pricing, i.e. no important premium or price reduction ( more than 1 % ) exists on any given twenty-four hours.
- The premium or price reduction in the ETF markets ( if any ) , disappears within a twenty-four hours and does non prevail for long.
- RESEARCH METHODOLOGY
As mentioned earlier, the focal point of the present survey is to analyze and compare the public presentation and trading features of ETFs across the Earth. This subdivision provides a brief overview of the research methodological analysis adopted to analyze each of these issues and the informations used in the survey.
- Performance of ETFs
Conventionally, the public presentation of common financess has been evaluated utilizing three classical public presentation steps, viz. , Sharpe ratio ( 1966 ) , Treynor ratio ( 1965 ) and Jensen’s alpha ( 1968 ) . However, since the implicit in investing aim of passively managed ETF is different from those of actively managed common fund [ 3 ] , these traditional public presentation rating methods are non considered appropriate for analysing the public presentation of ETFs.
The public presentation of an ETF is analyzed in footings of whether it has been able to accomplish its investing aim of tracking or retroflexing the returns of its underlying benchmark index. In order to compare the returns of ETFs with those of their implicit in indices, the present survey uses the methodological analysis adopted by Frino and Gallagher ( 2002 ) , Gallagher and Segara ( 2004 ) and Rompotis ( 2006c ) . In peculiar, it uses the undermentioned public presentation steps, each of which analyses a different facet of ETF public presentation.
- Hazard and Return Analysis: As a first estimate of ETF public presentation, the survey compares the mean day-to-day and hebdomadal hazards and returns of ETFs with those of their implicit in indices over semiannual intervals. Similar hazard and return features of ETF and its implicit in index indicates a satisfactory public presentation of the ETF.
- Arrested development Analysis: The survey uses the good known market theoretical account by regressing the returns of the ETF portfolio on the returns of the underlying market index. The beta estimation of this arrested development is used as an index of the portfolio reproduction scheme adopted by the ETF director. A beta equal to integrity reflects a full reproduction scheme, which implies that the fund invests in all the constituents of the underlying index in the same weightage as represented by the index.
- Tracking Error Estimation: An of import standard for measuring a inactive fund manager’s public presentation is through an appraisal of ‘tracking error’ , which quantifies the difference in returns of the fund and its implicit in index. Following the methodological analysis adopted by Frino and Gallagher ( 2002 ) , the survey uses three different steps of tracking mistake. These are:
- the norm of the absolute difference in returns between the fund and the index,
- the standard divergence of the return difference between the fund and the index, and
- the standard mistake of the arrested development of fund returns on underlying index returns.
- Performance Effectiveness: The survey so measures the public presentation effectivity ( or prejudice ) , i.e. the net under-performance or out-performance of ETFs over a period of clip, utilizing the undermentioned two steps:
- the norm of the arithmetic difference in returns between the fund and the index, and
- the alpha coefficient of arrested development of fund returns on underlying index returns.
- Cross-Country Comparison of Performance of ETFs
The survey attempts to do a cross-country comparing and supply comparative ranking of states in footings of their ETF public presentation utilizing three of the public presentation steps, viz. , reproduction scheme, tracking ability and public presentation effectivity.
- Trading Features of ETFs
In order to analyse the trading features of ETFs, the survey foremost tests their pricing efficiency, i.e. whether they experience important premiums or price reductions during any given twenty-four hours, and how much clip does it take for such premium/discount ( if any ) to vanish. Towards this intent the survey quantifies the day-to-day divergences between ETF’s trading monetary value and NAV ( Net Asset Value ) in pecuniary every bit good as per centum footings, and studies their frequence distribution. The continuity of such divergences is so examined utilizing a arrested development theoretical account. The survey besides provides a trading profile of ETFs to analyse other merchandising features of ETFs, such as their mean trading turnover.
- Data and Period of Study
ETFs were foremost introduced in the U.S markets in 1993, nevertheless they picked up gait merely after 1999. Since so ETFs have continued to turn and hold proliferated across planetary fiscal markets both in footings of their figure and assets under direction. By the terminal of first one-fourth 2012, there were over 3,169 ETFs, with assets deserving $ 1,536.7 billion, managed by 157 suppliers around the Earth. ( ETF Landscape, Q1 2012 )
Since the present survey purposes at analysing the ETFs across the Earth, and the survey of the whole existence of ETFs is non feasible, there is a demand to choose a representative sample for the intent of our survey. Our survey therefore analyses all the domestic ETFs that track the popular indices of five dominant states viz. U.S. , U.K. , Japan, Australia and India. These indices are the broad-based equity indices which represent the public presentation of the several markets. In all we study 11 popular indices and 17 ETFs that track such indices.
The clip period under survey extends from January 1993- March 2012. Each selected ETF has been analyzed over a clip period get downing from the first full fiscal twelvemonth of its trading till the terminal of the period under survey. The survey uses daily every bit good as hebdomadal informations in regard of shutting monetary values and NAVs of ETFs every bit good as the shutting values of the implicit in indices.
- Administration OF THE STUDY
The survey is organized into eight chapters including the present 1. Chapter II provides a conceptual model of ETFs by depicting its nature, trading mechanism, benefits and costs every bit good as its history, growing and development. Chapter III reviews major research surveies refering the public presentation and trading features of ETFs and provides a model for the present survey. The informations used and the inside informations about the methodological analysis adopted in this survey are provided in chapter IV. Chapter V, VI and VII are devoted to the empirical findings of the survey whereby Chapter V discusses the public presentation of ETFs, Chapter VI provides a cross-country comparing of ETF public presentation and Chapter VII discusses the trading features of ETFs under survey. Finally, chapter VIII presents the drumhead, decisions every bit good as the deductions of the survey.