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1 November 2015 CFA Institute Journal Review

Are Bond ETF Investors Smart? (Digest Summary)

  1. Louis A. Lemos

Past monthly performance is significantly positively correlated with inflows into bond exchange-traded funds, signifying that investors chase performance. Significant return chasing is found for various fund styles, including high-return, international, investment-grade, and Treasury inflation-protected securities. Timing ability is evidenced in outflows more than inflows.

What’s Inside?

The authors investigate the growth of bond exchange-traded funds (ETFs) and study the returns experienced by ETF flows. Their primary objective is to examine return-chasing behavior for bond ETFs, the impact of fund style on return chasing, and the ability of ETF flows to anticipate returns. Only three of the seven fund styles studied show evidence of smart selling as defined by the authors.

How Is This Research Useful to Practitioners?

Practitioners will find this study interesting because the authors investigate the significant growth of bond ETFs and the returns experienced by bond ETF flows, as well as return-chasing behavior for bond ETFs, for which there is a scarcity of research. The authors find return-chasing behavior for bond ETFs to be in line with previous studies that showed that investors chased performance with regard to equity and bond mutual funds.

Although the authors find significant return chasing for investment-grade, corporate, international, and Treasury Inflation-Protected Securities (TIPS) fund styles, there is little evidence of return chasing for US Treasuries.

The authors conclude by examining the extent to which bond ETF flows can anticipate returns and determine that outflows do suggest timing ability (32 bps per month of negative alpha). On the contrary, inflows are not as well timed or “smart,” which the authors define as investors purchasing (selling) funds with the highest (lowest) future returns. They highlight that the results should be interpreted with caution because the study considers a relatively short time period of approximately six years.

How Did the Authors Conduct This Research?

The authors’ initial sample of bond ETFs is derived from the CRSP Survivor-Bias-Free Mutual Fund Database. Several filters are applied to focus the sample, resulting in 135 bond ETFs with 4,243 observations for the 2008–13 time period (CRSP sample). SEC-reported gross flow data, via Form N-SAR, are obtained from Morningstar Direct and are matched by ticker to the CRSP sample. This combination results in 97 ETFs with 3,066 observations (N-SAR sample). The authors develop comprehensive summary statistics categorized by fund characteristics, returns, and market variables for both samples.

They estimate a bond ETF cash flow model, which is applied to the samples. Various bond ETF styles (long- and intermediate-maturity government, municipal, corporate investment grade, corporate high yield, international, and TIPS) are used to estimate the flow model equation.

The authors study whether ETF investors can time the purchasing and selling of ETF shares to produce excess returns. Regressions for the full sample consider an old-money portfolio, an inflow-weighted portfolio, and a zero-cost portfolio (long inflow portfolio and short old-money portfolio).

The authors next turn to outflows by examining an outflow-weighted portfolio and a zero-cost portfolio (long an outflow portfolio and short an old-money portfolio). Finally, they study going long an inflow-weighted portfolio and going long an outflow-weighted portfolio and short the old-money portfolio for the individual bond ETF styles.

Abstractor’s Viewpoint

The authors’ research, although it evaluates quite small sample sizes, provides interesting background information on bond ETFs and prior research that considers the drivers and impact of cash flows on equity and bond mutual funds and equity ETFs. Importantly, I believe the authors’ study is an important contribution to the ETF literature because it investigates return chasing for bond ETFs, for which there are apparently no prior studies.

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