Ohio State Study: Specialty Exchange Trade Funds Fail to Deliver Returns

COLUMBUS, Ohio – A study by an Ohio State University finance professor finds that specialty exchange trade funds often fail to deliver for investors.

Such funds – built around industries or themes such as cybersecurity or work-from-home businesses – are often targeted to “unsophisticated” investors, professor Itzhak Ben-David said in a statement, who want to get “easy money” from the stock market.

“These specialized ETFs are often promoted as the ‘next big thing’ to investors who are wowed by the past performance of the individual stocks and neglect the risks arising from under-diversified portfolios,” said study co-author Byungwook Kim, a graduate student in finance.

Traditional ETFs are broad-based funds that mimic index funds. working off large, diverse portfolios rather than a narrow segment. At the end of 2019, more than $4 trillion had been invested in 3,200 specialty funds.

In the study, the researchers looked at 1,086 ETFs –  613 broad-based and 473 specialty – traded on American markets between 1993 and 2019.

Whereas traditional ETFs saw relatively flat earnings, specialized ETFs lost about 4% of their value per year, with underperformance lasting at least five years after the funds’ launch.

“Specialized ETFs, on average, have generated disappointing performance for their investors,” said co-author Rabih Moussawi, assistant professor of finance at Villanova University. “Specialized ETFs are launched near the peak of the value of their underlying stocks and start underperforming right after launch.

The study also found that the people who typically invest in specialty ETFs are different than those putting their money into traditional ETFs.

Whereas institutional investors tend to own about 43% of the market capitalization of broad ETFs, they have less than 1% of the capitalization of specialized funds.

On the other hand, data from one online discount brokerage showed individual investors were “much more likely to invest” in specialty ETFs.

“Other research has suggested that investors using that discount brokerage exhibit sensation-seeking behavior and their holdings can be described as experience and curiosity holdings,” Ben-David said. “If you purchase a specialized ETF, you are likely to lose money because their underlying stocks are overvalued.”

Source: Ohio State News

Published by The Business Journal, Youngstown, Ohio.