Academic journal article IUP Journal of Applied Finance

Pricing Efficiency and Performance of Exchange Traded Funds in India [Dagger]

Academic journal article IUP Journal of Applied Finance

Pricing Efficiency and Performance of Exchange Traded Funds in India [Dagger]

Article excerpt

(ProQuest: ... denotes formulae omitted.)


Exchange Traded Funds, popularly known as ETFs, are a remarkable evolution in the investment industry and are increasingly challenging the dominance of open-ended mutual funds across the globe. ETFs at their core provide the investors with a basket of securities which can be bought or sold over a stock exchange. All day trading makes the ETFs more flexible than their counterpart's open-ended mutual funds and can also be sold short or at margin just like a stock. ETFs are different from mutual funds as the ETF units are not sold to the public for cash, instead the Asset Management Company(AMC) that sponsors the ETF (Fund) takes the shares of companies comprising the index from various categories of investors like authorized participants, large investors and institutions. In turn, it issues them a large block of ETF units. The price of the ETF tracks the value of the underlying index. This provides an opportunity to investors to compare the value of underlying index against the price of the ETF units prevailing on the exchange. They offer investors various benefits such as risk diversification, flexibility, transparency and real-time trading.

The inception of the Standard and Poor's Depository Receipts (SPDRs) on the AMEX Exchange in 1993 and the subsequent rapid growth of ETFs with products known as Qubes (QQQ), diamonds, and iShares, have enhanced investment choices and brought new challenges to the professional portfolio management. ETFs have grown globally at an exponential rate with ETFs assets size approximating $2.2 tn and an annual growth rate of 28% (Deutsche Report, 2014). In India, assets under management at ETFs rose from 59 cr in March 2009 to 394 cr in March 2012 to 5,239 cr in March 2014 (AMFI Report, 2014). ETFs are gradually becoming popular in India primarily due to low-cost structure, passive investment strategy, diversification, real-time trading and increased level of transparency. In India, ETFs were first introduced in the year 1994 with the launch of Morgan Stanley Growth Fund, but the fund failed to attract investors' attention due to its poor track record as well as large discount to the NAV. Things changed after the launch of Nifty Benchmark Exchange Traded Scheme (Nifty BeES) in December 2001. The fund set the record straight for ETFs in the country. Soon after, the ETF segment has grown slowly but steadily. The instrument has been adopted as a PSU disinvestment tool by the Government of India, and upon its launch in March 2014, it was an instant hit among investors where the government was able to successfully raise 3000 cr and the issue was oversubscribed by 1000. The government is again planning to relaunch the Central Public Sector Enterprises (CPSE) ETF to sell a 10% stake in Coal India for 23,700 cr. The present paper attempts to study the tracking ability, calculation of tracking error and presence and persistence of pricing efficiency of ETFs (if any).

Literature Review

Since the advent of ETFs in 1993, massive proliferation has been witnessed across sectors, asset classes, currency and commodities, which has challenged the dominance of traditional mutual funds. In order to provide an extensive understanding on exchange traded funds, the literature re view provi des a detailed overview of the nature, trading characteristics, performance, pricing efficiency, existence and persistence of premium/discount of exchange traded funds. The earliest work in ETFs is that of Gastineau (2001) who examined ETFs by tracing their origin in the US markets, describing their main types and the exchanges where they are traded, analyzing their characteristics and the operating mechanism and the benefits derived from ETFs for capital market participants, especially in the context of short selling for the determination of assets' size and fund manager's profitability. Carty (2001) observed the structural and trading characteristics of ETFs such as flexibility, convenience, risk diversification, tax efficiency and cost advantages. …

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