Nowadays exchange traded funds (ETFs) are getting more and more popular. Many investors believe that their risk-performance profile is better than ordinary index mutual funds. This seminar paper focuses on the real returns of both asset classes. It is based on a scientific paper written by Sharifzadeh et. al.(2012). The authors compared ETFs and index mutual funds which had quite the same composition. Additionally, they tested the risk-return profile of both, using the sharpe ratio. Interestingly, they found out that ETFs could not outperform index mutual funds and vice versa.
Table of Contents
1. Introduction
2. Differences between ETFs and Index Mutual Funds
3. Methodology
4. Result
4.1. Results for Hypothesis 1
4.2. Results for Hypothesis 2
5. Conclusion
Research Objectives and Themes
The paper examines whether Exchange Traded Funds (ETFs) offer superior performance compared to similar index mutual funds, aiming to identify if investors should prefer ETFs based on risk-return characteristics or other operational factors.
- Comparison of performance metrics between ETFs and index mutual funds.
- Evaluation of risk-return profiles using the Sharpe ratio and buy-and-hold strategies.
- Analysis of structural and operational differences between asset types.
- Investigation of the growth trends and adoption of ETFs in financial markets.
- Assessment of tracking errors and market price volatility.
Excerpt from the Book
2. Differences between ETFs and Index Mutual Funds
Generally, ETFs have a comparable structure like common Mutual Index Fund. However, some features of ETFs are very special and give some advantages to its investors. One big difference which has to be highlighted is the different trading possibilities. Index Mutual Funds can only be bought directly at a fund providing company or financial advisers. Orders are accepted during the whole trading day of stock markets, but transactions are only done at the end of a trading day, when the new price of the fund is published. The price that an investor has to pay is calculated with the Net Asset Value (NAV). On the other side, ETFs can be traded during the whole day (as the name Exchange Traded Fund suggests). The price that has to be paid does not have to be exactly the same like the NAV. It can be slightly different to the actual market value, which offers arbitrage possibilities, especially for institutional investors.
Additionally, important to mention is also the different way of buying and selling ETFs and mutual funds (more precisely open-end mutual funds). When people or institutions want to invest money in a mutual fund they buy a certain amount of shares. Therefore, their cash moves into the fund, the provider of the fund issues new shares and invests the incoming cash into the underlying securities. As a result, the number of shares of a single fund can change during its maturity. The number of shares of an ETF does not change because of its creation and redemption process. Large investors (most of the time financial institutions) are able to buy an ETF in exchange for the same amount of underlying’s that is tracked by the ETF, which is called Creation process. The redemption process works just the other way round. The amount of ETFs that is bought by investors can be traded intradaily at the stock markets.
Summary of Chapters
1. Introduction: The introduction outlines the research question regarding the performance comparison between ETFs and index mutual funds and provides a brief overview of existing literature on the subject.
2. Differences between ETFs and Index Mutual Funds: This chapter highlights the structural and operational distinctions, specifically focusing on trading mechanisms and the creation/redemption processes.
3. Methodology: This section explains the model used by Sharifzadeh et.al. (2012) to compare risk-adjusted returns, including the utilization of the Sharpe ratio and nonparametric hypothesis testing.
4. Result: The chapter presents the empirical findings regarding the two defined hypotheses, noting that results for both hypotheses are statistically insignificant.
5. Conclusion: The conclusion summarizes the findings, reiterating that the research cannot confirm superior performance of ETFs and suggests that their market growth is driven by cost advantages rather than performance.
Keywords
Exchange Traded Funds, Index Mutual Funds, Sharpe Ratio, Risk-Return, Performance Comparison, Financial Markets, Asset Management, Portfolio Diversification, Market Volatility, Net Asset Value, Creation Redemption Process, Investment Strategy, Statistical Significance, Arbitrage, Tracking Error
Frequently Asked Questions
What is the core focus of this research paper?
The paper investigates whether Exchange Traded Funds (ETFs) consistently outperform similar index mutual funds in terms of risk-return characteristics.
What are the central themes discussed in the work?
The main themes include the operational differences between ETFs and index funds, the impact of trading structures on performance, and an empirical analysis of their respective risk-adjusted returns.
What is the primary research goal or question?
The primary goal is to determine if the performance of ETFs is superior to index mutual funds for retail investors and fund managers.
Which scientific methodology is employed?
The study relies on the Sharpe ratio and nonparametric hypothesis testing to compare the risk-adjusted returns of 230 pairs of ETFs and index funds.
What is covered in the main body of the text?
The main body details the structural differences, explains the methodology of Sharifzadeh et.al. (2012), presents the empirical results of two specific hypotheses, and discusses their implications.
Which keywords characterize this work?
Key terms include ETFs, Index Mutual Funds, Sharpe Ratio, Risk-return profile, and Performance comparison.
Why were the results for the tested hypotheses deemed not significant?
The authors explain that the results lacked statistical significance, partly due to the limited historical data available for ETFs and the small sample size within the chosen timeframe.
How do ETFs and mutual funds differ regarding their trading process?
Unlike mutual funds, which are priced only at the end of the trading day based on NAV, ETFs can be traded intradaily on stock markets at prices that may fluctuate relative to their NAV.
What is the significance of the "creation and redemption" process mentioned in the paper?
This process is crucial for ETFs because it allows large institutional investors to exchange assets for shares, keeping the supply of ETF shares flexible without impacting the underlying fund holdings in the same way as open-end mutual funds.
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- BSc Oliver Baumgartner (Autor:in), 2013, Performance Comparison of European Exchange Traded Funds (ETF) and Index Mutual Funds, München, GRIN Verlag, https://www.grin.com/document/211829
