Abstract: Mutual funds offer two primary services: managing asset portfolios and creating liquid demandable shares. This paper shows that liquidity created by mutual funds induces investors to acquire information about illiquid assets in fund portfolios. We study this liquidity channel of information acquisition by examining trading suspension events in China, which turn stocks perfectly illiquid for prolonged periods. Consistent with our theoretical framework, illiquid stocks with large exposures to mutual funds experience increased information acquisition activities, and investors purchase and redeem fund shares to exploit the stale prices of such holdings. When trading resumes, large price movements of these stocks reflect the information acquired by investors.
Abstract: We show that an increase in passive exchange-traded fund (ETF) ownership leads to stronger and more persistent return reversals in the cross-section of US equities. Removing return components unrelated to liquidity strengthens the effect on short-term reversals, suggesting that passive ETF ownership decreases liquidity. Exploiting exogenous variation from reconstitutions in the Russell indices allows us to further examine the causal impact of passive ETF ownership on stock liquidity as well as other factors of interest. We find that more passive ETF ownership causes higher bid-ask spreads, more exposure to aggregate liquidity shocks, and higher idiosyncratic volatility. We assess whether market participants also price these effects by making use of option-implied tail risk measures, which capture the jump risk in returns. Our findings confirm that stocks with more passive ETF ownership are more prone to extreme price movements in line with recent theoretical work suggesting that passive investments make demand curves for stocks substantially more inelastic. Finally, we examine potential drivers of our results by decomposing a stock’s return variation into different types of information. We show, again using index reconstitutions, that higher passive ETF ownership reduces the importance of firm-specific information, consistent with the view that passive funds crowd out active investors who trade on fundamental information. In addition, passive ETF ownership increases the importance of transitory noise which we attribute to heightened exposure to market-wide sentiment shocks and short-term noise trading.
Abstract: We examine active ETFs, focusing on the recent innovation of less transparent active ETFs, to understand competition in the delegated asset market, particularly between ETFs and mutual funds. We find no cannibalization of mutual fund investor flows from newly cloned ETFs. Rather, the better reputation of the cloned mutual funds gives the new ETF advantages in attracting flows over their peers, even without better performance. We provide further evidence that investment companies introduce cloned ETFs for flow diversification – some of the cloned ETF flows are driven by a clientele difference from their mutual fund counterparts.
Discussant: Karamfil Todorov, Bank for International Settlements
