Abstract
This study investigates the effects of size on the risk-adjusted fund performance of US-publicly listed index-tracking passive equity exchange-traded funds (ETFs). Using panel quantile and Fama–MacBeth cross-sectional regression approaches, we determine that the asset-based size growth is informative in the risk-return trade-offs of ETFs, and that these ETFs do not follow a constant return-to-scale. The quantile regression results show that the rate of return-to-scale diminishes as the ETFs size increases and becomes negative for the most significant fund group. The size has a considerably substantial negative impact on the highest-performing clusters of ETFs, suggesting that the diseconomies of scale found in conventional active mutual funds affect the ETFs. The results align with Indro et al. (Financ Anal J 55: 74–87, 1999) findings of mutual funds that there are diminishing marginal returns to information acquisition and trading, and the marginal returns become negative when the fund exceeds its optimal size. This study provides further insights and understanding of the performance and size relationship of index-tracking passive equity ETFs.
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Notes
According to the center for research in security prices (CRSP) manual, index-tracking funds are identified as the CRSP index fund flag (funds with a value of “D”) that corresponds to “Pure Index Funds.” The study includes equity ETFs and mentions that the difference between traditional index-tracking funds and ETFs are small because both represent traded passive portfolios.
And it can uncover the role of fund attributes, such as number of holdings, fund age, lagged fund flow, lagged fund return, lagged fund size, investment styles, and fund types, in the size–performance relationship. Refer to Yan (2008) for further discussions on the role of investment factors and fund attributes on the size–performance relationship.
Refer to Koenker and Bassett (1978) for the technical aspects of estimating a QR model.
Koenker and Hallock (2001) discuss the properties and usefulness of the Quantile Regressions.
As VIX is a single time series variable, when using the Fama and MacBeth cross-sectional regression, it suppresses constant. Therefore, we replace VIX with historical volatility measured by historical standard deviation.
Chen et al. (2004) suggests using different benchmark models to mitigate fund size and style heterogeneity issues that may cause abnormal returns.
These factors and the risk-free rate are obtained from a Kenneth French’s website: http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html
The empirical results based on CAPM alpha are the same and are not reported.
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Paudel, K., Naka, A. Effects of size on the exchange-traded funds performance. J Asset Manag 24, 474–484 (2023). https://doi.org/10.1057/s41260-023-00321-4
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DOI: https://doi.org/10.1057/s41260-023-00321-4
Keywords
- Exchange-traded funds
- Panel quantile regression
- Index-tracking funds
- Asset size
- Scale economies
- Risk-adjusted alpha