Exchange-Traded Confusion: How Industry Practices Undermine Product Comparisons in Exchange Traded Funds

Abstract

Despite their incredible popularity and importance to modern capital markets, exchange traded funds (ETFs) are extremely difficult to compare side-by-side. Investors who successfully navigate the initial challenges of product choice overload, and opaque index construction methodology, soon encounter a wide array of discretionary operational, management, marketing, and financial practices of ETF sponsors that combine to undermine simple product and performance comparisons. This dilemma is compounded by disclosure effectiveness challenges given investor cognitive limitations and behavioral tendencies. This article is the first scholarly work, amongst a growing body of ETF studies, to illustrate why accurate “apples to apples” product comparisons in ETFs are so challenging (at times even impossible) to perform. It presents a variety of ETF case studies to demonstrate this challenge including recent performance instabilities in the coronavirus pandemic.

It advocates for continued positive momentum around investor-focused reforms in ETFs, building on encouraging steps undertaken by the U.S. Securities & Exchange Commission in its recent “Rule 6c-11” under the Investment Company Act of 1940. It makes several recommendations to improve ETF product comparisons including standardizing website formats and layouts for information presentation, uniform calculation methodologies of key ETF variables, an ETF naming convention, and standard terms in sustainable investing. ETF investors would also greatly benefit from a systematized and structured electronic reporting mechanism whereby standardized data is provided by ETF sponsors to a centrally controlled public repository. Additional studies are warranted on strategic ETF disclosure ordering, digital enhancement, and added contextual discussion around critical concepts like arbitrage and index composition methodology. The ETF “model portfolio” industry is also an emerging concern that should be assessed, and the article provides suggestions to reduce informational opacity and improve comparative assessments.

Keywords: ETF, exchange traded fund, exchange traded product, securities, securities disclosure, capital markets, asset managers, model portfolios, behavioral finance, behavioral economics, Investment Company, Investment Company Act, Exchange Act, Securities Act, Arbitrage, Indexing, Passive Investing

JEL Classification: K22, K29, G01, G02, G14, G20, G23, O16