By Ananth N. Madhavan

"In Exchange-Traded cash and the hot Dynamics of making an investment, Ananth Madhavan examines the quiet transformation of asset administration in the course of the upward push of passive or index making an investment. A closely-related phenomenon is the increase of exchange-traded cash (ETFs). An ETF is an funding car that trades intraday and seeks to duplicate the functionality of a selected index. ETFs have grown considerably in dimension, range, and

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Exchange-traded cash (ETFs) have grown considerably in measurement, variety, and industry importance in recent times, producing significant curiosity from traders, lecturers, regulators and the Read more...

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The ETF structure also enables lower fees than traditional active mutual funds. First, unlike ETFs, mutual funds interact directly with investors and hence accrue distribution and record-​keeping costs. By contrast, for an ETF these costs are borne by the investor’s brokerage firm. Mutual funds may levy fees (such as transfer agency fees or 12b-​1 fees that compensate the fund for distribution and service) that ETFs do not, raising the cost of ownership. Second, since mutual funds, through their structure, must interact with the market when faced with a net inflow or outflow, they can incur trading costs and cash drag if they cannot immediately put inflows to work.

Recent industry trends may obviate these traditional drawbacks. For instance, many companies now offer commission free brokerage trades for investments into their sponsored ETFs. New firms termed “Robo-​advisors” (also known as digital advisors) automate investing, typically using a menu of low-​cost index-​tracking ETFs, again overcoming behavioral biases that may inhibit the use of ETFs by ordinary investors. The structure and operation of ETFs requires investor education, especially as funds increasingly move out of equities into fixed income and factor based investing.

Lower values of ψ imply fast arbitrage and less serial dependence in pricing errors. As market makers are risk-​averse and face market impact costs, price does not instantly revert back to expected value (net transaction costs), but rather corrects over time. This is also the case if dealer capital is limited. Note that ψ also reflects the correlation in flow from period to period. If flows are strongly temporally correlated and investors crowd on the same side of the market, the ETF will trade at prices above or below fundamental value for multiple periods.

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