Country-specific ETFs: An efficient approach to global asset allocation
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Joe¨lle Miffre is Associate Professor of Finance at EDHEC Business School. My research focuses on portfolio management, with special emphasis on alternative assets (hedge funds, commodities), performance evaluation, non-normality risks, ETFs and momentum strategies. EDHEC Business School, 393 Promenade des Anglais, Nice 06202, France. Tel: þ 33 (0)4 93 18 32 55; Fax: +33 (0)4 93 1878 41; E-mail: [email protected]
Abstract The paper shows that country-specific exchange traded funds (hereafter ETFs) enhance global asset allocation strategies. Because ETFs can be sold short even on a downtick, global strategies that diversify risk across country-specific ETFs generate efficiency gains that cannot be achieved by simply investing in a global index open or closed-end fund. Besides, the benefits of international diversification can be achieved with country-specific ETFs at a low cost, with a low tracking error and in a tax-efficient way. For all these reasons, country-specific ETFs may be considered as serious competitors to traditional country open and closed-end funds. Journal of Asset Management (2007) 8, 112–122. doi:10.1057/palgrave.jam.2250065 Keywords: country-specific ETFs, global asset allocation, short-selling
Introduction Exchange traded funds (hereafter ETFs) are shares that closely track the performance of an index. They offer, in one trade, the benefits of diversification and index tracking1 at a low cost. The first ETF, the SPDR, was launched in 1993 and was designed to passively mimic the S&P500 index. Since then the variety of indices that ETFs follow have kept expanding, ranging from equity and bond indices worldwide to style and sector portfolios. As an investment vehicle, ETFs have become so popular that Fuhr (2001) estimated that ‘most days, two or three ETFs are on the list of the top five most actively traded stocks in the AMEX’. ETFs assets under management grew at a 132 per cent average annual rate from 1995 to 2000, with a combined value in the US that stands at $240 bn today (Investment Company Institute, 2005). ETFs are effective tools for investment, risk and tax management. They are frequently used for passive investment, short-
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term speculative trading, tactical asset allocation, hedging and arbitrage. Alternatively, asset managers use them to carry out market neutral strategies, to time the market, implement sector and style rotation strategies, or diversify a domestic portfolio across countries and global industries. In a way similar to futures, they can also be used to simulate full investment of small mandates into stocks. At times, the most liquid ETFs are even substitutes for the cash necessary to meet redemption. In the end, the many advantages of ETFs lead (Gastineau 2001: 98) to the conclusion that ‘in the year aheady we would expect nearly all equity index funds to have an ETF share class’. Developments in this field have already occurred. For example, Vanguard, an established leader in the passive fund management industry, announced in January 2004 that it was expand
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