Are Flows Costly to Etf Investors?

Abstract

Authorized participants create and redeem exchange-traded fund (ETF) shares in response to supply and demand imbalances in the secondary market. For the majority of ETFs, share creations and redemptions take place as in-kind transactions, but a growing number of ETFs feature cash creations and redemptions. The authors investigate whether ETF flows are costly to investors. Using a reasonable proxy for the potential cost of fund flows, they find evidence of underperformance associated with flows to ETFs featuring cash creations and redemptions and tracking international benchmarks. Because ETF flows do not predict subsequent returns and the authors do not find evidence the funds are susceptible to market-timing strategies, the costs likely stem from the transaction costs associated with the portfolio trades that are necessary to accommodate cash liquidity.

TOPICS: Exchange-traded funds and applications, exchanges/markets/clearinghouses, in markets