Investment is commitment of fund by buying securities or financial assets in capital market, commodity market or real estate market. There are various investment avenues for an investment like equity, bonds, commodity, real estate, bank deposits etc. Investors can choose the investment avenues according to their risk and return profile. Mutual fund is a new instrument which pools the money from investors and invests in equity, bond and government securities. Mutual fund is best option for investors who have less knowledge about stock market and trading strategy. There are various types of schemes floated by mutual fund like Growth Fund, Income Fund, Balanced Fund, Money market Schemes, Index Fund and many others.

In capital market, there is an innovative instrument called Exchange Traded Fund which is giving threat to the existence of index fund because of many advantages given by ETF. Exchange Traded Fund has grown as one of most successful investment innovation in history of capital market. As on the end of 2011, the combined assets under management (AUM) of all ETFs traded on exchanges around the world were US$ 1.52 trillion, an increase of approximately 1400 percent from the assets in 2001. There are now close to 4,000 different ETFs listed on over 50 exchanges. ETFs have a relatively short history. It is commonly acknowledged that first ever ETF was the Toronto Stock Exchange Index Participants introduced in 1990 and designed to track the TSE-35 stock index. In India, ETF was started in 2001 by the Nifty Benchmark Exchange Traded Schemes (Nifty BeES). Nifty BeES was taken over by Goldman Sachs Assets Management Company. Now in India, there are over 40 ETFs listed on National Stock Exchange and a majority of the ETFs are passively managed, meaning that the ETFs track their underlying benchmark indices. In India, mainly, there are four types of ETF are functioning namely International indices ETF, Gold ETF, Debt ETF and Equity ETF. Most popular types of Exchange Traded Fund in India are Gold ETFs and Index ETFs. Exchange Traded Fund is a fund which has the feature of both a stock and a mutual fund. ETFs can be traded on stock exchange like a stock and it also gives the benefit of diversification and professional management like a mutual fund. It is a better option than closed ended fund because prices of ETF traded closely to the NAV of ETF but in case of closed ended fund, units of fund is traded at a large price deviation fund’s NAV. Main reason of ETF trading so closely to NAV of fund is its unique feature of in kind creation and redemption facility.

Exchange Traded Fund provides many other benefits which distinguished it from index fund and making it more attractive to the investor like intraday trading, tax efficient, low expense ratio and cost transparency. There is a very few literature on exchange traded fund because it has relatively very short history. Still it attracted the interest of the many researcher and academicians due to its increasingly popularity and successes. The purpose of this review is to provide systematic review of existing literature on ETFs which will help the researchers and investors in understanding the ETFs more precisely and identifying research gaps. Review of literature on ETF has been divided into four sections:-

· Section- A : Review of Studies related to Introduction of ETF in General

· Section- B : Review of studies related to price efficiency of Exchange Traded Fund.

· Section -C : Review of Studies related to performance of Exchange Traded Fund

· Section- D : Review of studies related to comparison of index fund and Exchange Traded Fund.

Section-A: Review of Studies related to Introduction of ETF in General:

Exchange Traded Fund was started in 1990 with the establishment of Toronto Exchange Traded Index Participation to track TSE-35. Earlier researches mainly concentrated on introduction of ETF and demonstrating its tax efficiency and types of ETF, its unique redemption and creation feature. Poterba and Shoven (2002) compared pre-tax and post-tax return of largest ETF, the SDPR trusts which tracks S and P 500 with returns of largest equity index fund named Vanguard Index 500. Study found that return of index fund was slightly more than ETF. Study also suggested that ETF is a good option for taxable investor because it is tax efficient and also provides comparable return with low cost. Sorannakom (2003) recommended a financial product named ETF for stock exchange of Thailand (SET). The study also explained the steps for creating first ETF named SET50 Index which can be a good hedging tool for large investor and institutional investor. Result indicated that ETF is a better option than index mutual fund because of tax efficiency, liquidity, diversification and ability to sell short with small transaction cost. Wang (2010) investigated development and future prospects of gold ETF as national security and past trend indicated that in China, savings of people is high and they also have long term love for gold. Study demonstrated that Gold ETF is a good option for China which can solve many problems like diversification, inflation protection and currency hedging and it also has many problems like advantages like tax and cost efficiency, liquidity, safety, uniformity in prices. Singh (2011) compared ETF with mutual fund on the basis of fee effect and time spectrum. They found that on the basis of time spectrum, mutual fund is a good option for long term investment than ETF and on the basis of fee structure ETF is a good option. And study also revealed that ETFs are becoming more popular among both poor and standard class. Bhatt (2012) compared ETF with open ended mutual fund, closed ended mutual fund, index fund and individual stock. Study revealed that ETF provides investor opportunities of investment, trading and it is better option in terms of tax-efficiency, intra-day trading, less cost, short sale and traded on margin.

Section- B: Review of Studies related to price efficiency of exchange traded fund:

Exchange Traded Fund is a fund that can be traded on stock exchange at premium/discount to their NAV. Many studies have been conducted to examine price efficiency of ETFs. ETFs cannot be traded at large discount and premium because of existence of unique creation and redemption process which gives arbitrage opportunities to large investor and financial institution. Ackert and Tian (2002) investigated pricing efficiency of Standard and Poor’s Depositary Recepits that track S and P 500. They found that SPDRs are priced in market efficiently and are not traded at heavily discount and premium. On the other hand, mid Cap SPDR which was designed to track the performance of S and P Midcap 400 index is traded at significant discount. Garg (2014) examined the performance of 7 equity ETFs and 5 Gold ETFs for a period of Jan. 2002 to Dec. 2009. Study demonstrated significant pricing deviation in terms of discount and premium which shows the presence of unexploited arbitrage opportunities in Indian ETF market. Zheng and Osmer (2013) examined the pricing efficiency of ETF focused on investing in China. They found that increase in USA dollar against renminbi, better performance of market, increase in turnover ratio and larger fund size is associated with lower ETF discount, on other hand, only trading infrequency accounts for higher ETF discount. Chateris (2013) studied four domestic and three foreign South African listed ETFs and found five out of seven trades at a premium to their NAV on average and two at discount. Study also indicated that this persistence exists for not more than two days. Bas and Sartoglu (2015) evaluated the pricing efficiency of 16 ETFs operating in Turkish Capital market for period of 2005-2013. Study found that Turkish ETFs are traded closely to their Net Assets Value and there are no arbitrage opportunities in this area.

Section-C: Review of Studies related to performance of Exchange Traded Fund:

Many studies have been done to measure the performance and tracking ability of Exchange Traded Fund. Tracking error is deviation of return of ETF return from underlying Index return. Tracking error can be measured by various Techniques like standard deviation (TEa), average of absolute difference between return of ETF and underlying index (TEb) and the root-mean-square deviation of the fund from that of the benchmark (TEc). Factors that contribute to tracking error are usually management fees, transaction costs, dividend and cash holding, choice of replication strategy. Rompotis (2006) investigated the cost-benefit performance of 74 ishares ETFs during period of 2002 to 2006. Results indicated that expenses are negatively correlated with size of fund. And aged iShares charges higher expenses. Study also focused on persistence of expenses and performance and found that expense ratio persists both in short run and long run. But rating and performance persists partially only in long run. Additionally, research also revealed that return of ishares is negatively associated with expenses and positively associated with turnover. Gayatri and Bhuvaneswari (2009) examined the performance of five ETFs which are listed on NSE for period of 2005-2007. Analysis showed that UTISUNDER and NIFTYBEES performed better than BANKBEES, LIQUIDBEES and JUNIORBEES. Wong and Shum (2010) examined the performance of 15 ETFS in bullish and bearish market for a period of 1999-2007 by applying the Sharpe ratio technique. Result indicated that ETFs provide high returns in bullish market than bearish market. Study also demonstrated that returns of ETFs are not correlated with their volatility Further research revealed that two ETFs tracking the same underlying index performed differently. This shows that there exists active portfolio management in ETFs. Goyal and Joshi (2011) appraised risk and return of Gold ETF in comparison of risk and return of NSE for a period of March 2008 to November 2010. Techniques used for analysis are Alpha, Beta, Sharpe ratio and Treynor ratio. Study revealed that prizes of ETF are less volatile than NSE index and confidence of investor in ETF is also increasing day by day. Prasnna (2012) using Data envelopment analysis and Sharpe ratio found that ETF gave excess return of 3% p.a. in comparison to CNX NIFTY. It was found that Gold is outperforming other conventional assets classes with a CAGR of 17.1% in INR terms and 14.5% in USD terms since last ten year. The empirical evidence showed that Gold ETF is less volatile than Gold and is better option for investment in Gold. Sinha and Dutta (2013) attempted to analyze the performance of Goldman Sachs Gold Exchange Traded Fund taking into consideration NAV of schemes and prices of physical gold for a period of 2001-2012. Methods used for analysis are tracking error and trend analysis. Study found that NAV returns are in close proximity with domestic prizes of gold returns showing lower tracking error and better performance of Goldman Sachs Gold Exchange Traded Fund. Garg (2014) examined the performance of 7 equity ETFs and 5 Gold ETFs for a period of Jan. 2002 to Dec. 2009 by using standard deviation. Study revealed that significant tracking error in performance of ETFs and performance is consistent for long period.

Section- D: Review of Studies related to comparison of index fund and Exchange Traded Fund:

Exchange Traded Fund is giving threat to the existence of Index Fund. Index Fund also tracks a board based index but ETF provides benefits like intraday trading, low fees, tax efficiency which is not provided by Index Fund. Rompotis (2005) compared performance of 16 ETFs with index funds for period of 4-3-2001 to 11-20-2002 which tracks same index. It was found that in terms of return and risk, ETF and index fund do not have significant differences. Both fund’s return are almost same. Additionally, he also found that return of index fund and ETF is not more than underlying index. Study also demonstrated by using regression analysis that there is positive relationship between ETF’s return and expense ratio. Sharifzadeh (2012) empirical compared performance of Exchange Traded Fund and Index Fund performance by taking a sample of 230 paired matches of ETF and Index Fund. Techniques used in study are Sharpe ratio, risk adjusted buy and hold total returns and Wilcoxon signed rank test. Study demonstrated that ETFs outperformed Index fund 134 times in terms of Sharpe ratio and 125 times in term of risk adjusted buy and hold total return respectively. But t-test showed that there is no significant difference in returns of Index Fund and ETF. So, investor should choice ETF on the basis of advantage like product efficiency, liquidity not on the basis of return. Narend (2014) compared the performance of Index Fund with ETF tracking either S and P BSE SENSEX Index or CNX Nifty Index by using three parameters tracking error, Jenson alpha and active returns. Study revealed that alpha is negative for both ETF and Index fund and in the terms of active returns, ETF performed better than index fund. Study also demonstrated that tracking error is more in the case of ETF than Index fund and Index fund performed better than ETF by showing less tracking error and less negative alpha for Index fund. Paliwal (2014) checked tracking efficiency of ETF and Index fund in volatile market by taking sample of 2 pair of ETF and index fund for period of 2007 to 2012. Methodology used for testing was average return, standard deviation and t-test. Result indicated that index fund performed better than ETF in tracking large cap and board market index and ETF showed lower tracking error than index fund in case of mid-cap, small cap and narrower index. Study also demonstrated that ETFs are less volatile than index fund and that of underlying index.

CONCLUSION:

Exchange Traded Fund is a low cost innovative investment instrument demand for which is growing day by day. This paper examined literature available on Exchange Traded Fund by dividing into four strands Exchange Traded Fund in General, Pricing Efficiency of Exchange Traded Fund, Performance of Exchange Traded Fund and comparison of Exchange Traded Fund with Index Fund respectively. The empirical studies related to pricing efficiency indicated those ETFs which track Domestic Index trade at lower premium/discount from its NAV in comparison to international index. Studies related to performance of Exchange Traded Fund gave mix result means in some cases, ETFs tracked their underlying well and in others, it underperformed. And in last, Studies related to comparison of ETFs with Index Fund showed that ETF could not give much higher return than index Fund instead of its low management fees and tax efficiency. It can be concluded that Studies on ETF in India is very few and could not give answer of various research question. But Exchange Traded Fund is an emerging investment instrument and is attracting the attention of various scholars. So we can expect that literature of ETF will grow not only on these strands but also on other aspects of ETFs too.

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Received on 16.03.2017 Modified on 10.04.2017

Asian J. Management; 2017; 8(2):349-352.

DOI: 10.5958/2321-5763.2017.00053.1