Exchange Traded Funds: An assessment of investment alternatives

Rasmus Zander Iversen & Elsebeth Gylling Sørensen

Student thesis: Master thesis


Exchange traded products (ETPs) have seen tremendous growth internationally, but in a Danish context they are still relatively unknown. Exchange traded funds (ETFs) are the most popular subgroup of ETPs, and equity-based ETFs make up the largest share of global ETP asset under management (AUM). Equity-based ETFs are often described as a low-cost alternative to investing in traditional mutual funds (MFs). The purpose of this thesis is to investigate whether this is true for the Danish private investor. The investigation is performed based on an empirical performance analysis, an analysis of the surrounding environment in terms of regulation, tax and competition, and on thorough discussion of the literature on ETF structures and potential risks associated therewith. Based on a set of criteria, nine ETFs and 19 MFs are chosen to be applied in an empirical performance test. Over a time period of 3-5 years (depending on the starting date of ETFs) 12 MFs shows negative performance, with two of these significant. One fund shows significantly positive performance. By synthetically replicating the ETFs the analysis is extended to an 11-year period. In this analysis 14 MFs is found to have negative performance, with four of these significant. One still exhibits positive significant performance. Introducing timing into the models reveals 13 MFs performed negatively, while only one is significant. No fund shows significantly positive performance. When extending the horizon to 11 years, 14 funds shows negative performance, but now seven of these are significant. Overall, based on performance for these specific funds equity-based ETFs is found to be a viable alternative to MFs. Despite equity-based ETFs performing well compared to MFs, a review of the Danish tax system, along with regulation as distribution, is found to hinder the adoption of ETFs for private investors. To address the confusion this thesis analyses the financial structures of 4 different ETPs. The equity-based ETFs used in performance testing, leveraged ETFs, exchange traded commodities (ETCs), and exchange traded notes (ETNs). It is found that even though these four all belong to the ETP family, the financial structure, the complexity, and the risk levels differ considerably. Analysis of equity-based ETFs shows no difference between ETFs using physical replication and engaging in securities lending and those using swaps to replicate a benchmark. Overall, both these types of equity-based ETFs are found to be reasonably safe investment vehicles for Danish private investors. Analysis of the three other types of ETPs reveals that these products are more complex. The Danish private investor will therefore have to understand the difference between equity-based ETFs, and the other types of ETPs.

EducationsMSc in Finance and Accounting, (Graduate Programme) Final Thesis
Publication date2012
Number of pages156