Working Paper: NBER ID: w28369
Authors: Itzhak Bendavid; Francesco Franzoni; Byungwook Kim; Rabih Moussawi
Abstract: The interplay between investors' demand and providers' incentives has shaped the evolution of exchange-traded funds (ETFs). While early ETFs invest in broad-based indexes and therefore offered diversification at low cost, later products track niche port- folios and charge high fees. Strikingly, over their first five years, specialized ETFs lose about 30% in risk-adjusted terms. This underperformance cannot be explained by high fees or hedging demand. Rather, it is driven by the overvaluation of the underlying stocks at the time of the launch. Our results are consistent with providers catering to investors' extrapolative beliefs by issuing specialized ETFs that track attention- grabbing themes.
Keywords: Exchange-Traded Funds; Investor Demand; Financial Innovation; Market Performance
JEL Codes: G12; G14; G15
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Specialized ETFs underperform (G19) | overvaluation of underlying stocks at launch (G10) |
| Launch timing coincides with peak valuations driven by investor sentiment (G14) | Specialized ETFs underperform (G19) |
| Specialized ETFs cater to investor sentiment (G41) | issuance of specialized ETFs (G23) |
| issuance of specialized ETFs (G23) | disappointing performance (D29) |
| ETF type (F33) | investor behavior (G41) |
| High media exposure (L82) | reduces sensitivity to fees (G19) |
| Specialized ETFs (G23) | chosen as speculative vehicles (G11) |