Passive investors, active moves: ETFs IPO participation in China

Abstract

We examine a unique phenomenon among exchange-traded funds (ETFs) in the Chinese stock market, finding that ETFs pervasively participate in initial public offerings (IPOs) to profit from underpricing. The ETF IPO participation passes primary market benefits (about 4.68% per annum) to investors, providing benefits from hard-to-reach investment opportunities. These active moves showing ETFs are not entirely passive highlight the gains of the active management. However, we observe that this activity leads to increased non-fundamental volatility and short-term return reversals, as well as decreased investment-q sensitivity among ETF member stocks, presenting a negative externality. Using a policy shock as the quasi-natural experiment, we establish the causality of these effects, underscoring the dual nature of ETFs active management. 

Keywords: Exchange Traded Funds, Chinese stock market, IPOs