Measuring Performance of Exchange Traded Funds

32 Pages Posted: 7 Feb 2013 Last revised: 18 Feb 2013

Marlène Hassine

Lyxor Asset Management, ETF Strategy

Thierry Roncalli

Amundi Asset Management; University of Evry

Date Written: February 5, 2013

Abstract

Fund selection is an important issue for investors. This topic has spawned abundant academic literature. Nonetheless, most of the time, these works concern only active management, whereas many investors, such as institutional investors, prefer to invest in index funds. The tools developed in the case of active management are also not suitable for evaluating the performance of these index funds. This explains why information ratios are usually used to compare the performance of passive funds. However, we show that this measure is not pertinent, especially when the tracking error volatility of the index fund is small. The objective of an exchange traded fund (ETF) is precisely to offer an investment vehicle that presents a very low tracking error compared to its benchmark. In this paper, we propose a performance measure based on the value-at-risk framework, which is perfectly adapted to passive management and ETFs. Depending on three parameters (performance difference, tracking error volatility and liquidity spread), this efficiency measure is easy to compute and may help investors in their fund selection process. We provide some examples, and show how liquidity is more of an issue for institutional investors than retail investors.

Keywords: Passive management, index fund, ETF, information ratio, tracking error, liquidity, spread, value-at-risk

JEL Classification: G11

Suggested Citation

Hassine, Marlène and Roncalli, Thierry, Measuring Performance of Exchange Traded Funds (February 5, 2013). Available at SSRN: https://ssrn.com/abstract=2212596 or http://dx.doi.org/10.2139/ssrn.2212596

Marlène Hassine

Lyxor Asset Management, ETF Strategy ( email )

Paris
France

Thierry Roncalli (Contact Author)

Amundi Asset Management ( email )

90 Boulevard Pasteur
Paris, 75015
France

University of Evry ( email )

Boulevard Francois Mitterrand
F-91025 Evry Cedex
France

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