Institutional Trading Behavior in the ETF Market

Abstract

We examine the trading behavior of institutional investors in the Exchange Traded Fund (ETF) market from 1993 to 2007. We concentrate on the relation between cross-sectional institutional ETF ownership and returns, particularly on the relation between changes in ownership and future returns, between past returns and institutional ownership, and between changes in ownership across institution classes (i.e. herding). Our results do not show evidence of a significant relation between changes in institutional ownership and future ETF returns. However, consistent with the use of negative feedback investment strategies, institutional investors tend to exhibit excess demands for past losers, especially in sector and international ETFs. They also exhibit high degrees of herding behavior, with banks driving the bulk of these results. Furthermore, their herding behavior is influenced by their experience in the ETF market and by certain ETF characteristics, such as liquidity and size, suggesting an aversion for information uncertainty leads them to herd.

Keywords: ETFs, institutional investor behavior, institutional ownership, herding, feedback investment strategies

JEL Classification: G10, G11, G14, G20