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Measuring Performance of Exchange Traded Funds

Author

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  • Hassine, Marlène
  • Roncalli, Thierry

Abstract

Fund selection is an important issue for investors. This topic has spawned abundant academic literature. Nonetheless, most of the time, these works concern only active management, whereas many investors, such as institutional investors, prefer to invest in index funds. The tools developed in the case of active management are also not suitable for evaluating the performance of these index funds. This explains why information ratios are usually used to compare the performance of passive funds. However, we show that this measure is not pertinent, especially when the tracking error volatility of the index fund is small. The objective of an exchange traded fund (ETF) is precisely to offer an investment vehicle that presents a very low tracking error compared to its benchmark. In this paper, we propose a performance measure based on the value-at-risk framework, which is perfectly adapted to passive management and ETFs. Depending on three parameters (performance difference, tracking error volatility and liquidity spread), this efficiency measure is easy to compute and may help investors in their fund selection process. We provide some examples, and show how liquidity is more of an issue for institutional investors than retail investors.

Suggested Citation

  • Hassine, Marlène & Roncalli, Thierry, 2013. "Measuring Performance of Exchange Traded Funds," MPRA Paper 44298, University Library of Munich, Germany.
  • Handle: RePEc:pra:mprapa:44298
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    References listed on IDEAS

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    Cited by:

    1. Kent T. Saunders, 2018. "Analysis of International ETF Tracking Error in Country-Specific Funds," Atlantic Economic Journal, Springer;International Atlantic Economic Society, vol. 46(2), pages 151-160, June.
    2. F. Riva & A. Calamia & L. Deville, 2013. "Liquidity in European equity ETFs: What really matters?," Post-Print hal-00846610, HAL.
    3. Hurlin, Christophe & Iseli, Grégoire & Pérignon, Christophe & Yeung, Stanley, 2019. "The counterparty risk exposure of ETF investors," Journal of Banking & Finance, Elsevier, vol. 102(C), pages 215-230.
    4. Martin Širůček & Václav Ruml & Petr Strejček, 2018. "Measuring the Performance of Leveraged and Non‑Leveraged ETF’s," Acta Universitatis Agriculturae et Silviculturae Mendelianae Brunensis, Mendel University Press, vol. 66(5), pages 1357-1367.
    5. Mirel Flavius Popa, 2017. "Portfolio diversification with ETFs," Scientific Papers 0006, Institute of Financial Studies.

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    More about this item

    Keywords

    Passive management; index fund; ETF; information ratio; tracking error; liquidity; spread; value-at-risk;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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