CHAPTER-2

REVIEW OF LITERATURE

Exchange Traded Funds have a brief history. ETFs have not faced
extended researching interest. The literature presents very few records
of studies related to this issue, particularly in empirical level. The most
significant papers are introduced in this chapter. The literature can be
subdivided into the following categories,

Studies related to ETFs in general, covering description of ETFs,

demonstrating the tax and other certain advantages of ETFs in
comparison to traditional mutual funds.

Studies providing an introduction to ETFs, focusing on their origin,

describing their main types and the exchanges where they are (or were)
traded, analyzing their characteristics and operating mechanism. They
also indicate the benefits the participants of capital markets gain by
ETFs‘ existence.

Some papers compare ETFs and index funds, demonstrating that the
main differences among them are related to management expenses,
transaction fees and tax efficiency. They also suggest that the tracking
error‘s comparison between ETFs and index funds is difficult because
of the lack of a true benchmark for comparison.

Some authors study performance and the trading characteristics,

performance is studies by applying Sharpe ratio, Treynor ratio and
Jensen alpha and trading characteristics are studied by investigating
the ability of ETFs to accurately replicate the performance of their
underlying indexes, for finding the existence of tracking error, In
parallel, they study whether the ETFs are trading at their NAVs, to find
whether they trade at a premium from their net asset value or discount
to their NAVs.

Few authors try to compare the performance of ETFs with that of broad
market index, to prove that a portfolio of passive ETFs can provide
above market returns with the least risk assumed. They also study the
performance persistence of ETFs over the market index.

Few other compare the performance of Active (vs) Passive ETFs by

applying the Jensen‘s Alpha as a performance measure. The literature
is discussed below,

M. JAYADEV (1996)1 In this paper an attempt is made to evaluate the

performance of two growth oriented mutual funds (Mastergain and
Magnum Express) on the basis of monthly returns compared to
benchmark returns. For this purpose, risk adjusted performance
measures suggested by Jenson, Treynor and Sharpe are employed. It is
found that, Mastergain has performed better according to Jenson and
Treynor measures and on the basis of Sharpe ratio it‘s performance is
not upto the benchmark. The performance of Magnum Express is poor
on the basis of all these three measures. However, Magnum Express is
well diversified and has reduced it‘s unique risk where as Mastergain
did not. These two funds are found to be poor in earning better returns
either adopting marketing or in selecting under priced securities. It can
be concluded that, the two growth oriented funds have not performed
better in terms of total risk and the funds are not offering advantages of
diversification and professsionalism to the investors.

Ackert and Tian (2000)2 show that discounts on the price of SPDRs had
no economic significance between 1993 and 1997. They find that, in
contrast to closed-end mutual funds, the difference between SPDRs and
their net asset value is economically insignificant. The difference is
somewhat larger for MidCap SPDRs, but still substantially less than the
typical closed-end fund. They conclude that the mechanisms to create
and destroy shares act to limit deviations from net asset value. Based
on institutional ownership data, they conclude that individuals rather
than institutions invest in SPDRs. They also find that the returns of
SPDRs are not excessively volatile relative to the underlying index.

Dellva (2001)3 applies a cost comparison among the primary trackers of

S&P 500 Index, comparing funds of ETFs and index mutual funds
investing classes. He exhibits a significant benefit of ETFs with
reference to annual expenses, even though they shoulder transaction
costs and commissions that concern brokerage firms. This advantage
becomes greater if an investor does not liquid his shares for a long time
period.

Bernstein (2001)4 offers a primer on ETFs. Beyond the definition and

description of ETFs, he demonstrates the tax and other certain
advantages of ETFs in comparison to traditional mutual funds.

Gastineau (2001)5 provides an introduction of ETFs, focusing on their

origin, describing their main types and the exchanges where they are
(or were) traded,analyzing their characteristics and operating
mechanism. He also indicates the benefits the participants of capital
markets gain by ETFs‘ existence.

Frino and Gallagher (2001 6 empirically study index fund tracking error.
They explain that the primary factor that causes index fund tracking
error is the cost of transactions which includes liquidity concerns, fund
cash flows, dividends, volatility of the benchmark, corporate activity,
and index composition changes. They find that the tracking error
associated with the S&P 500 index funds follows a quarterly (seasonal)
pattern. The tracking error is lowest at the end of each calendar quarter.
They surmise that this seasonal effect may be the result of the timing of
dividend payments by the funds. Other reasons for tracking error, they
conclude, may have to do with the changes in the index itself.

Jonne M. Hill and Barbara Muelle r (2001)7 made a research on ETFs and they
concluded that Tracking errors and returns based on fund NAV relative to the index
reflect characteristics of the product structure. In addition, price-to- index returns and
tracking error reflect ETF prices that are captured at a different time from the
underlying index and the short-supply and demand factors relevant to the ETF, as
well as the hedging instruments used by the market makers. NAV tracking error is
much lower than price-to-index tracking error and is the most useful measure in
assessing the long-term characteristics of an ETF relative to its underlying index.

Elton, Gruber, Comer and Li (2002)8 they examine the characteristics

and the performance of SPDRs. Firstly they examine the return on
Spiders and Since a Spider has its basic value determined by the S&P
Index, they compare the return on Spiders to the return on the S&P
Index and then try to decompose any differences in return to see what
accounts for them.they break Spider return into two components: the
return due to changes in NAV and the return due to deviations of NAV
from price. Secondly they study the Spider price deviate from NAV.
Lastly they compare Spiders to other instruments whose performance is
also directly related to the S&P Index. In addition to the possibility of
holding the shares that comprise the S&P Index directly or holding
Spiders, investors can approximate the return on an index by holding an
index fund or by holding short-term debt instruments and an index
future. They find that the net asset value of SPDRs moves closely to its
market price, as a result of the ―in kind‖ creation and redemption‘s
mechanism. Further,they show that SPDRs underperforms the S&P 500
Index and its low costs index funds counterparts. They attribute this
underperformance to the lost income caused by the policy of not
reinvesting the dividends received on the underlying assets and holding
them in cash.

Poterba and Shoven (2002)9 compare the pre-tax and after-tax returns of
SPDRs and Vanguard index fund; both track S&P 500 Index, finding that
they substantially present the same records of performance. They
combine these findings with the tax efficiency of ETFs and they
conclude that ETFs offer investors a less taxable method to invest in a
broad market index and to achieve returns analogous to their index
funds counterparts.
Engle and Sarkar (2002)10examine the magnitude and persistence of
discounts both daily and intradaily.On average, they find that ETFs are
efficiently priced since only small deviations were seen,lasting for only
a few minutes. Both domestic and international ETFs are examined,
each from an end-of-day perspective and from a minute-by-minute intra-
daily framework. The overall finding is that the premiums/discounts for
the domestic ETFs are generally small and highly transient, once
mismatches in timing are accounted for. Large premiums typically last
only several minutes. The standard deviation of the premiums/discount
is 15 basis points on average across all ETFs, which is substantially
smaller than the bid-ask spread. For international ETFs, the findings are
not so dramatic. Premiums and discounts are much larger and more
persistent, frequently lasting several days. The spreads are also much
wider and are comparable to the standard deviation of the premiums.

Scott Rasmussen(2002)11 The purpose of this study was to quantify the

comparative costs and benefits of buying long with ETFs and index
mutual funds; specifically, the differential effects upon returns of
expenses, dividend treatment active management, capital gains
distributions, and transaction costs. It is found that although ETFs are
hailed as cost- and tax-efficient alternatives to index mutual funds, their
relative performance for a given index depends heavily on the costs and
tax consequences of the individual funds. SPY has attracted a lot of
attention to itself and to ETFs in general because its low expenses,
capital gains distributions, and bid-ask spread make it an attractive
alternative to S&P 500-based mutual funds, but the same is not true for
all ETFs. Other ETFs tend to have expense ratios closer to, or even
higher than, their mutual fund competitors, in addition to making larger
capital gains distributions and having wider bid-ask spreads. In general,
ETFs become more cost-effective relative to mutual funds as the size
and the timehorizon of investments increase.

Philippe Jorion (2003)12 in his article explored the risk and return
relationship of active portfolios subject to a constraint on tracking-error
volatility (TEV), which can also be interpreted in terms of value at risk.
Such a constrained portfolio is the typical setup for active managers
who are given the task of beating a benchmark. The problem with this
setup is that the portfolio manager pays no attention to total portfolio
risk, which results in seriously inefficient portfolios unless some
additional constraints are imposed. The study reflected that TEV-
constrained portfolios are described by an ellipse on the traditional
mean–variance plane. This finding yields a number of new insights.
Because of the flat shape of this ellipse, adding a constraint on total
portfolio volatility can substantially improve the performance of the
active portfolio. In general, plan sponsors should concentrate on
controlling total portfolio risk.

Kostovetsky (2003)13 compares ETFs and index funds, demonstrating

that the main differences among them are related to management
expenses, transaction fees and tax efficiency. He also suggests that the
tracking error‘s comparison between ETFs and index funds is difficult
because of the lack of a true benchmark for comparison.

Gerasimos G. Rompotis (2003)14 In this paper the author compares ETFs

and Index Funds Performance during the time period from 4/3/2001 to
11/20/2002, using a set of 16 ETFs and index funds that in pairs track the
same indexes. He estimates their average return and mean risk level,
finding that they substantially produce quite similar results. He
regresses ETFs and index funds return on return of the underlying
indexes and finds out that they don‘t achieve any excess return than
this of their benchmarks. He computes ETFs and index funds average
tracking error, confirming their analogous tracking ability. Finally, he
presents ETFs and index funds major sources of costs and, regressing
average return on expense ratio, he exhibits a significant positive
relation of our ETFs with their expense ratio. This relation is very shortly
verified in index funds

Gastineau (2004)15 looks at why ETFs underperform index funds that

track the same index. His focus is on the operational efficiency of the
funds‘ management. By inspecting the historical returns (through 2002)
of iShares, Spiders, and Vanguard indexes following the S&P 500 and
the Russell 2000, he notes that the ETFs typically underperform their
respective index funds.He says that a significant portion of the
underperformance is likely due to the failure of ETF fund managers to
reduce their transactions costs in a way that is common among index
fund managers. When indexes change their composition and/or
weighting, the index fund manager will time his modifications to the
fund in order to minimize transactions costs. He also notes that
although there are no legal barriers against this timing in ETFs, ETF
managers have not yet adopted this method of cost reduction.
Gallagher and Segara (2004)16. This study examines the performance
and trading characteristics of exchange-traded funds (ETFs) in
Australia. They investigate the ability of index oriented (classical) ETFs
to track underlying equity benchmarks on the Australian Stock
Exchange, and provide a comparison of the tracking error volatility
between these types of market-traded instruments and equity index
funds operated off-market. The authors find that classical ETFs closely
track their respective indices, but they note that ETFs in Australia have
not faced the same degree of acceptance in comparison to the reception
of ETFs in other markets.

Andy Lin and Fan-Ju (2004)17 In addition to the characteristics and

performance of TTT (Taiwan‘s first ETF), this research examined
whether ETF is a better choice for Taiwan‘s investors by applying
Markowitz‘s portfolio theory, Sharpe ratio, Treynor measure and Jensen
index . In the mean-variance analysis, the empirical result shows that
TTT has a smaller standard deviation as compared to its fifty underlying
stocks, which makes TTT an attractive investment tool for Taiwan‘s
conservative investors. However, further examination shows that the
performance of TTT is relatively unsatisfactory in comparison with the
market benchmark portfolio and a hypothetical portfolio.Evidently, TTT,
based on the market capitalization in determining the allocation
weights, does not yield the most appealing portfolio while the
hypothetical portfolio, which applies the Markowitz‘s theoretical
framework, is showing more attraction during the sample period.

Jares and Lavin (2004)18 study this issue for Japan and Honk-Kong
WEBs that trade on the AMEX. Non-tradability of the underlying stocks
is an especially meaningful concern in this case since Asian markets
are closed for the day before U.S. markets open. For these ETFs, an
Indicated Optimized Portfolio Value serves as the Indicative NAV and is
disclosed throughout the day. It is based on stale stock prices and
accounts solely for changes in exchange rates. Jares and Lavin find
frequent discounts and premiums for the period ranging from 1996 to
2001. Moreover, there is predictability in returns giving rise to highly
profitable trading rules.
Simon and Sternberg (2004)19 This paper examines the forecasting
power of German, UK and French iShares for the next day returns of the
underlying Morgan Stanley country equity indexes and assesses
whether European iShares overreact to developments after the close of
European trading. The findings indicate that although deviations of
European iShare prices from net asset values (NAVs) at the close of US
trading have significant forecast power for next day NAV returns, they
overpredict. Deviations of closing iShare prices from their NAVs also
lead to next day iShare price reversals that average roughly 3/8 of the
size of the deviations. Finally, the paper demonstrates the profitability of
trading rules that exploit the tendency of European iShares to overreact
to late day US trading activity. also find significant premiums and
discounts at the end of the day and overreaction for European ETFs
traded on the AMEX. Hence, if the trading system appears to enhance
pricing efficiency for traded funds, some inefficiency seems to remain
for ETFs replicating illiquid or foreign benchmarks.

Andy Lin and Anthony Chou(2006)20 this research investigates: (1) the
characteristics and formation of tracking errors of the TTT, (2) the
underlying factors which influence the premium/discount of the TTT,
and (3) the pricing factors of the TTT‘s return and trading volume.
Interesting conclusions are reached. First, the tracking error of the TTT
iscmainly constituted by its cash dividends, whose impact became so
obvious in the peak dividend payout season. Second, the management
expenses are identified as the main factor causing the gap between two
different tracking error series. Third, the effect on TTT tracking errors of
stock replacement operations is documented. It is evident that there are
three apparent shocks, signaling potential arbitrage opportunities.
Nevertheless, this arbitrage potential is deemed limited and the duration
is short. Finally, the multivariate model shows that the TTT
discount/premium could be attributed to its own volatility and market
return. And the return of the TTT is highly correlated with the general
stock market movements and its arbitrary opportunity. However, the
trading volume of the TTT is merely affected by its own price volatility.

Nikolaos T. Milonas* and Gerasimos G. Rompotis** (2006) 21 In this paper

they study the performance and the trading characteristics of a sample
of 36 Swiss Exchange Traded Funds during the period 2001-2006. Using
daily data they find that Swiss ETFs underperform their underlying
indexes and encumber investors with greater risk. They also find that
Swiss ETFs do not adopt full replication strategies and the magnitude of
tracking error is substantial to an approximate average of 1.02% .
Further investigation reveals that the tracking error is positively related
to the management fees and risk of ETFs while the impact of expenses
on ETFs performance is negative on ETF investor returns. Finally, in
regression results they estimate that the volume of Swiss ETFs is
positively affected by the intraday price volatility, the number of trades,
and the trading frequency while a significant part of volume is unrelated
to the above factors.

Manuel Ammann, Stephan Kessler and Jurg Toble r(2006) 22 stated that for
investors, it is important to know what trading strategies an asset manager pursues to
generate excess returns. In this paper, they proposed an alternative approach for
analyzing trading strategies used in active investing. They used tracking error
variance (TEV) as a measure of activity and introduced two decompositions of TEV
for identifying different investment strategies. To demonstrate how a tracking error
variance decomposition can add information, a simulation study testing the
performance of different methods for strategy analysis is conducted. In particular,
when investment strategies contain random components, TEV decomposition is found
to deliver important additional information that traditional return decomposition
methods are unable to uncover.

Gerasimos G. Rompotis(2006)23 This paper constitutes a presentation of

empirical research on Exchange Traded Funds. Using daily data for a
sample of 30 American ETFs during the period between 4/3/2001 and
8/7/2002, the study first investigates the price relation among ETFs and
underlying indices, finding that these values are not equal. Further, it is
discovered that ETFs are mainly traded in premium in regard to their Net
Asset Values. Afterwards, he calculates the sample‘s percentage return,
which, on average, is negative but stands closely to zero, and standard
deviation, which is low enough, indicating the great degree of ETFs
portfolio‘s diversification. Applying single regression estimations, it is
found out that the falling of capital markets after the abnormal growth
until latest‘s 2000 affects ETFs to behave conservatively. Finally, he
uses three methods to measure the gap among ETFs and underlying
indices return, the well known tracking error, finding that this difference
is not much greater than zero, implying that ETFs‘ performance moves
closely to the tracking indices.

Tzu-Wei KUO and Cesario MATEUS (2007)24 The aim of this paper was to
investigate the performance and persistence of 20 iShares MSCI
country-specific exchange-traded funds (ETFs) in comparison with S&P
500 index over the period July 2001 to June 2006.In this analysis the
Sharpe, Treynor and Sortino ratios were used as risk-adjusted
performance measures. To evaluate performance persistence i.e., if
there is any relationship among past performance and future
performance, they applied the Spearman Rank Correlation Coefficient
and the Winner-loser Contingency Table.The conclusions can be
summarized as follows. First, ETFs can beat the U.S.market index based
on risk-adjusted performance measures. Second, past performance of
iShares MSCI country-specific ETFs can predict future performance,
based on annual return.

Gerasimos G. Rompotis(2007)25 This paper consists of a comprehensive

empirical research on iShares exchange traded funds performance and
trading characteristics. At first, he investigates the ability of iShares to
accurately replicate the performance of their underlying indexes, finding
that there is a significant tracking error among iShares and indexes
returns, especially for iShares that track the international capital
indexes of Morgan Stanley. In parallel, he exhibits that iShares mainly
trade at a premium from their net asset value. Further, he demonstrates
that tracking error is strongly affected by iShares expense ratio and risk
and we provide evidence that tracking error is also induced by the
premium and the trading volume of iShares. Besides, he finds that
premium is affected positively by tracking error, while volume, which
reflects the liquidity of iShares, is oppositely related to premium. It is
also demonstrated that the lagged premium has sufficient predictive
power on return, since performance is estimated to be negatively
related to the lagged premium. Finally, the study provides very limited
evidence that the volume is negatively related to the lagged premium
and lagged return. In contrast volume is influenced strongly positively
by the intraday price volatility of iShares.

Mustafa Mesut Kayali (2007)26 This study investigates the pricing

efficiency of the Dow Jones Istanbul 20 (DJIST),the first exchange
traded fund in Turkey trading on the Istanbul Stock Exchange and
following the performance of the Dow Jones Turkey Titans 20 Index
since January 14, 2005. In particular, he examines the deviations of
price from net asset value (NAV), or premiums and discounts, over the
first year of DJIST‘s trading. It is found that there is a close pricing
relationship between the two price series and document smaller
deviations of price from NAV. That is, the DJIST trades at a smaller
discount on average. Although this discount is statistically significant, it
does not seem to be significant economically. Also, the premiums and
discounts do not persist over time and disappear within two days.
Therefore, he concludes that the market for the DJIST is efficient and
deserves credit from international investors seeking exposure to an
emerging stock market.

Gerasimos G. Rompotis(2008)27 The performance and the trading

characteristics of 62 German Exchange Traded Funds during the period
11/04/2000-12/09/2006 are investigated in this paper. Using weekly data
we find that, on average, German ETFs slightly underperform their
benchmarks and encumber investors with greater risk than indexes.
Also found that a number of 26 ETFs of the sample do not follow full
replication strategies resulting in a substantial mean tracking error of
1.07% . By regression analysis, it is revealed that the tracking error is
positively affected by risk, bid-ask spread and management
fees.Additional research shows that the expense ratio relates positively
to volatility, absolute premium and bid-ask spread, and relates
negatively to assets. The negative relationship among expenses and
assets reveals the achievement of economies of scale when the size of
ETFs increases. In addition, the tracking error, expense ratio and
absolute premium are found to positively affect the bid -ask spread.
Finally, in regression results we find that the weekly risk of ETFs
positively influences their trading volume while a significant portion of
volume is unexplained.
Benchmark Funds Asset Management Company(2008)28 research
department did research in early 2008 on the topic of ―Myth of Eternal
Alpha‖ It has often been argued that individual active fund managers
are consistently able to exploit anomalies and aberrations that may
exist in the market and while considering out performance/ under
performance one should look at longer periods.

Svetina and Wahal (2008)29 study a sample of 584 domestic equity,

international equity, and fixed income Exchange Traded Funds from
their inception to the end of 2007. The basic objective of their study is to
analyze the performance of ETFs and the nature of competition created
by them for index mutual funds and for the incumbent ETFs. The
findings show that on average, ETFs underperforms their benchmark
indices and are not immune from tracking error. A comparison of ETFs
and index funds reveal that almost 83 percent of all ETFs track indices
for which there are no corresponding index mutual funds. These ETFs
generally track esoteric non-mainstream indices, effectively expanding
the passive investment opportunity set for investors. ETFs that compete
directly with index mutual funds deliver slightly better performance
when compared to retail index funds and equivalent to the performance
of institutional index funds. Thus, while providing at least comparable
performance, ETFs also provide immediacy. The impact of this is that
the entry of ETFs that track the same index as incumbent index funds
reduces net flows to index mutual funds. Moreover, they find that the
introduction of competing ETFs permanently reduces the demand for
incumbent ETFs in the same asset class and investment style category.

J.Gayathri and P.Bhuvaneswari (2009)30 This paper examines the

performance of ETFs listed on NSE from 2005 to year by comparing the
returns and risk of the ETFs with the return and risk of the index. Sharpe
ratio and Treynor ratio were used. The result showed that NIFTY BeES
was the best performer.

Gerasimos G. Rompotis (2009)31 This paper expands the debate about

―active vs. passive‖ management using data from active and passive
ETFs listed in the U.S. market. The results reveal that the active ETFs
underperform both the corresponding passive ETFs and the market
indexes. With respect to risk-adjusted returns, both active and passive
ETFs provide investors with no positive excess returns, an expectable
finding for the passive ETFs but not for the active ETFs which are aimed
at beating the market. Going further, the underperformance of active
(2009)ETFs is depicted to the low performance rates such as the Sharpe
or the Treynor ratios they receive relative to the passive ETFs and the
indexes. Furthermore, regression analysis on the selectivity and market
timing skills of ETF managers indicate that the managers of both the
active and passive ETFs are lacking in such skills. However, the passive
managers are not expected to have such skills. Finally, tracking error
estimates indicate that the discrepancy between ETF and index returns
is greater for active ETFs However, this result is to be expected as the
active ETFs do not target to replicate the performance of the indexes.

Stijn Zweegers (2010)32 The extended Sharpe ratios of the ETFs are directly tested
to the extended Sharpe ratios of the mutual funds. Both investment strategies did not
outperform the benchmark according to the extended Sharpe ratio, since the average
ratios both are negative. The actively managed mutual funds did however outperform
the passively managed ETFs according to a T-test with a significance level of five
percent. Meaning that according to the extended Sharpe ratio, investing in mutual
funds would have been better over the evaluation period than investing in ETFs.
Given that the mutual funds give a better return relative to their risk. Mutual funds did
not significantly outperform the benchmark according to the Jensen‘s alpha since they
have a negative average alpha tested at a significance level of five percent or less. The
overall managers‘ goal is not accomplished. However, the mutual fund managers did
significantly outperform the alternative investing strategy, ETFs. The T-test shows a
significant outperforming with a significance level of five percent.The overall
conclusion of this papers research is that the active mutual funds managers
outperformed the passive ETFs managers.

P. Natarajan and M. Dharani(2010)33 Nifty BeES is the first Exchange

Traded Funds in the Indian Capital Market and its daily returns are
compared to benchmark returns. The Researcher found out that Nifty
BeES basically overperforrmed their benchmark while they endorsed
their investors with lesser risk than the standard deviation of the Nifty
Index. Further, this paper analyses the relationship between portfolio
returns and market returns by using Simple Regression Model. The
Researcher discovered that returns of the Nifty BeES for price was not
related to the index returns, but returns of the Nifty BeES for NAV was
related to the index returns. This was due to the price of the Nifty BeES
in the secondary market being based on supply and demand while NAV
of the Nifty BeES was based on the underlying index. Finally, this paper
examined the observed deviation between returns of the Nifty BeES and
Nifty Index.Applying three methods, the Researcher concluded that the
average tracking error fluctuates from approximately 0.59% to 0.907%
for price and 0.049% to 0.549% for NAV. All the methods, which were
used in this study for calculating tracking error, did not produce the
same results. During the study period of 6 years, portfolio returns of the
Nifty BeES beat the market returns and hence it can be considered as
one of the investment products in the promising Indian capital market

Prashanta Athma and Raj Kumar(2011)34 The study covers the trends
and progress of ETFs and Index Funds in India and to evaluate the
performance of ETFs vis-à-vis Index Funds in India. The study is based
on secondary data and covering the period of five years from 2005 to
2009 for the purpose of evaluating performance of select ETFs and
Index Funds in India. Since inception, the data has been collected for
the purpose of analyzing trends and progress of ETFs and Index funds
in India. The parameters for evaluating the performance are Net Asset
Value, Risk, Return, Expenses Ratio, Tracking Error, Reward to
Variability and Differential Return. The statistical tools like Standard
Deviation, Beta, Alpha, R-squared and Sharpe Ratio are used for data
analysis. It is concluded that ETFs have given better opportunity for the
small investors in terms of diversified portfolio with a small amount of
money; low expense ratio, reduced tracking error, lower risk and
volatility as compared to Index Funds. The ETFs can become a best
investment alternative, provided, awareness is created among the
investors.

Pedro Kono , Pan Yatrakis ., Sabrina Segal (2011)35 This study tests the
market efficiency of the Japanese equity market. The analyses compare the
performance of a portfolio consisting of exchange-traded funds (ETFs) with that of
the overall market, exemplified by the Topix Index, during the period of June 30,
2008 to June 30, 2009. The ETF portfolio is constructed a ccording to the Modern
Portfolio Theory (MPT) developed by Harry Markowitz in 1952. The study concludes
that an optimal ETF portfolio can outperform an overall market index when
performance is measured using the Sharpe ratio, i.e., the return per unit of r isk.

Gerasimos G. Rompotis (2011)36 The paper assesses

whether exchange-traded funds (ETFs) can beat the market, as it is
expressed by the Standard and Poor (S&P) 500 Index, examine the
outperformance persistence, calculates tracking error, assesses the
tracking error persistence, investigates the factors that induce tracking
error and assess whether there are predictable patterns in ETFs‘
performance.. The author uses a sample of 50 iShares during the period
2002-2007 and calculates the simple raw return, the Sharpe ratio and the
Sortino ratio, regresses the performance differences between ETFs and
market index, calculates tracking error as the standard deviation in
return differences between ETFs and benchmarks, assesses tracking
error‘s persistence in the same fashion used to assess the ETFs‘
outperformance persistence, examines the impact of expenses, risk and
age on tracking error and applies dummy regression analysis to study
whether the performance of ETFs is predictable. The results reveal that
the majority of the selected iShares beat the S&P 500 Index, both at the
annual and the aggregate levels while the return superiority of ETFs
strongly persists at the short-term level. The tracking error of ETFs also
persists at the short-term level. The regression analysis on tracking
error reveals that the expenses charged by ETFs along with the age and
risk of ETFs are some of the factors that can explain the persistence in
tracking error. Finally, the dummy regression analysis indicates that the
performance of ETFs can be somehow predictable.

Alok Goyal and Amit Joshi (2011)37. This paper studies the financial
performance, variations and also analyses the risk behaviour of the
selected Gold ETFs in comparison of NSE. The data for this has been
taken from the NSE website. The period taken for the study is March
2008 to November 2010. Analysis is made by using financial tools like
Sharpe‘s index, Treynor‘s ratio by calculating alpha, beta and standard
deviation of the selected funds.

DR.PRASHANTA ATHMA and Ms SUCHITRA K (2011)38 This paper stresses

upon the inclusion of Gold ETF in a portfolio for risk diversification; to assist the
investor in the selection of best Gold ETF option and to analyze the tax implications
of Gold ETF. Simple statistical tools like Averages, Standard Deviation and Co-
efficient of Variation are used. For the construction of portfolios, three most actively
traded securities namely Reliance Industries Ltd, ICICI Bank Ltd and State Bank of
India (SBI) are taken as one portfolio and the other portfolio includes Gold ETF and
top two actively traded securities in order to reflect upon the effect of inclusion of
Gold ETF in a portfolio.

DR. PREETI SINGH (2011)39 In this paper ETFs are compared with Mutual Funds.
It had been found from all the above discussion that ETFs are more reliable than
mutual funds. If the present situation of the world is analyzed most of the trading is
taking place on barter system. Individuals having one particular good wait for the
proper time by analyzing the market trend and then sale it in exc hange of the money
or other goods. Majority of the world‘s population do not hold precious assets what
they can invest into the business. Rather majority belongs to subclass or poor
community which has to earn money rapidly to meet their basic needs. Keeping all
these aspects in mind Exchange is the better option rather than availing the mutual
funds which are more expensive and more time consuming. While considering the
managers of mutual funds investments, there are more chances that managers may
exploit the interests of investors by not letting them know properly about their current
status. Also in case of mutual funds there always are conflicts of interests, the reason
behind could be it is very hard to manage a big investment than managing the small
investments as is in the case of exchange trade funds. There are few things necessary
to observe before on enter into the exchange trade. Exchange trade is the derivative of
index fund that totally operate on the basis of previous market values and trends.
Before investing it should be clear in one‘s mind that he knows all the steeps and
slops of market values or if some trading agent got to be involved he should have
tremendous grip on the market flow and twists.By considering all the above
mentioned facts it is found that exchange trade is the most appropriate trade as it
bears less expenses have more risks but less loses. Also it is friendly to the traders
having less capital in hand. Exchange trade follows the market trends the money of
investors can be liquefied according to desires whenever there is need to buy or sell
the stock. Hence the easiest and convenient way of making money through trade is
the exchange trade fund and is gaining the popularity due to its flexible mode of
operation.
Reena Aggarwal (2012)40 Exchange traded funds (ETFs) are one of the most
innovative financial products introduced on exchanges. As reflected by the size of the
market they have become popular among both retail and institutional investors. The
original ETFs were simple and easy to understand, however some recent products
such as leveraged, inverse, and synthetic ETFs, are complex and have additional
dimensions of risk. The additional risks, complexity, and reduced transparency have
resulted in heightened attention by regulators. Concerns related to systemic risk and
excess volatility, suitability for retail investors, lack of transparency and liquidity,
securities lending and counterparty exposure, among others have been raised. These
concerns are being addressed by a shift towards multiple counterparties,
overcollateralization, and disclosure of collateral holdings and index holdings. The
appropriate regulatory and market reforms can ensure the continued success of ETFs.

41
John P. Plamondon & DePaul(2012) This paper compares returns of ETFs
holding physical commodities and ETFs holding derivative products to their
respective spot commodity returns to identify significant performance differences
based on the ETF assets. They regress ETF returns on spot commodity returns to
estimate beta and R2 values. They use these Beta and R2 values to evaluate the
relationship between the ETFs and their spot prices. They found that the physical
ETFs perform more consistently with their spot commodities; these products are more
likely to provide the expected risk exposure investors desire. Also this paper performs
two mean comparison tests: the first compares the returns of the ETFs with their spot
commodities; while the second compares the Sharpe Ratios of the ETFs with the
Sharpe Ratios generated by their spot commodities. Their analyse of the Sharpe
Ratios finds that futures based ETFs have considerable performance divergence from
the physical commodity depending on if the futures market is in backwardation or
contango. Finally this paper evaluates the performance of the stack and strip methods
used by WTI Crude Oil based ETFs. They found that the use of a strip method
improved the performance of the WTI Crude Oil ETF when the contango in the
futures market became more severe, and eroded performance as the market became
flat or backwardated.

Harip R. Khanapuri(2012)42 Exchange traded funds (ETFs) have

completed a decade of their presence in Indian capital markets although
their popularity has grown very recently. Since the ETFs are issued on
the basis of their underlying assets, their price movements are
supposed to follow those of the underlying index or other assets they
represent. The paper evaluates comovemet between prices of ETFs in
India and those of their underlying assets using the econometric
technique of Vector Autoregressions. The findings suggest that while
comovements are stronger in equity based ETF, such relation does not
exist in commodity based ETF markets. The findings have significant
implications on investment style to be adopted by investors in ETF
market.
P. Krishna Prasanna (2012)43 The concept of Exchange-Traded Funds
(ETFs) is very popular in foreign countries, but in India, it is still in the
initial growth phase. This research paper examines the characteristics
and growth pattern of all the 82 exchange traded schemes floated and
traded on Indian Stock markets, and evaluates their performance using
Data Envelopment Analysis (DEA). On an average, ETFs grew at 37%
annually during the period 2006 -2011in India. These funds consistently
outperformed the market index and generated higher returns. ETFs
generated excess returns of 3% p.a. as against CNX NIFTY, which is the
Indian equity market bench mark. Gold ETFs provided 13% excess
returns as compared to the returns on the equity market and attracted
large investments in the post financial crisis years. Data Envelopment
Analysis ranked domestic and overseas fund of funds as efficient funds,
which were floated by foreign Asset Management Companies (AMCs)
and the AMCs with Joint Ventures in India. Among the foreign AMCs,
Franklin Templeton was found to offer the most efficient fund. These
efficient funds are found to have higher Sharpe ratios, indicating that
the DEA ranking is in broad consensus with the evaluation done using
Sharpe ratios. However large funds were not found to be efficient funds.
This infers that the fund size does not indicate superior performance

Dr. Kaushal Bhatt (2012)44 Investment is the commitment of funds by

buying securities or other monetary or paper (financial) assets in the
money markets or capital markets, or in fairly liquid real assets, such as
gold, real estate, or collectibles. An investment can be described as
perfect if it satisfies all the needs of professional investors. There are
large numbers of investment av-enues for savers. Some of them are
marketable, liquid, while others are non-marketable. This paper
addresses Exchange Traded Funds (ETFs), the index investments that
are a cross between exchanges listed corporate securities and open-
ended mutual funds. While ETFs are now competing with mutual funds,
they have a very different history and operational structure. It is
important for investors to know the difference between mutual funds
and ETFs and few investors fully understand ETFs. This paper focuses
on conceptual and theoretical aspects of ETFs in India. It covers its
comparison with mutual funds

Shefali Sinha and Mahua Dutta (2013)45 Goldman Sachs Asset

management (India) Private Limited is the first mutual fund house which
came up with the concept of scheme of Gold exchange traded fund in
2007. As, the scheme's performance is directly related to the domestic
price of gold. It's growth over a period of time is not reflected by some
of the research studies. The study was undertaken to fill the research
gap with emphasis on determining the potential of generating the
performance returns of scheme of Goldman Sachs Gold exchange
traded fund from the period 2007-2012. The main objective of the study
(a) to identify the performance of returns of Net Asset Value for the
period (b) to identify the performance of returns of domestic price of
Gold for the period (c) to determine the trend analysis of computed Net
Asset Value returns and (d) to determine the trend analysis of domestic
price of gold returns. The hypothesis in this study involves growth rate
of Net Asset Value returns & domestic price of gold returns. For this
purpose, secondary data was collected historical net asset value
prices & domestic price of gold for the period 2007-2012. Computation
of daily net asset value returns & domestic price of gold returns is taken
into account for five years to identify the tracking error. The methods
used for interpretation of data in the study are tracking error and trend
analysis. The trend analysis shows that the net asset value returns are
in close proximity with domestic price of gold returns through tracking
error. Lower tracking error indicates the better performance of the
scheme.

Swati Garg & Dr. Y. P. Singh(2013)46 This paper empirically compares the
performance of two competitive financial instruments available to Indian
investors, namely Exchange Traded Funds (ETFs) and Index Funds. A set of
five ETFs and Index Funds that in pairs track the same benchmark indices
has been analyzed in this study over a period ranging from June 2006 to
December 2009. The analysis demonstrates better performance of ETFs in
terms of their re plication strategy, tracking ability as well as performance
effectiveness over long-term investment horizon. However, there is an
evidence of potential disadvantage of ETFs from very short-term investor‗s
point of vie w.

SURESHA.B(2013)47 Price risk is the major risk faced by all investors.

Although price risk specific to an underlying can be minimized through
diversification, market risk cannot be diversified away. Price risk
depends on the volatility of the underlying held within a portfolio. In this
study an attempt has been made to test the volatility of Gold ETF in
India. Sample 14 listed Gold ETFs of NSE were taken to measure the
volatility. The study also investigates the price risk associated due to
inter correlation factors which are un diversifiable.
Annualized Actual Volatility (AAV) model is used to calculate volatility
and t test is computed for significance. GOLDBEES, GOLDSHARE,
KOTAKGOLD, RELGOLD, SBIGETS have highest (significant at 1% )
price volatility as compared to other counterparts and poses higher
price risk to the investors. AXIS, HDFCMFGETF, IPGETF, QGOLDHALF,
RELIGAREGO have moderate price volatility at 5% significance level.
Interestingly, BSLGOLDETF, IDBIGOLD, MGOLD, CRMFGETF have least
insignificant volatility and indicate the least price risk among the
samples ETF. The correlation among these samples Gold ETF is
positive except in case of CRMFGETF. Knowing the volatility helps in
deciding possible range of values that an underlying will be in and when
an investor knows how much volatility he is exposed to, he can make
informed decisions on his investments .

Prof. Dr. S. Kevin(2013)48 The efficiency of trading in securities market is

a matter of serious concern for investors as well as regulators.
Innovations in securities market environment can adversely affect
market efficiency. Index futures and index ETFs are two such
innovations in the securities market. Both these instruments have the
stock market index as their underlying asset. All the three instruments
together constitute a group of informationally linked instruments traded
simultaneously and continuously in the securities market.
This paper analyses empirically the price behavior of stock market
index, index futures and index ETFs in the Indian securities market. The
price data for one year (April 2011 to March 2012) have been used for
the analysis. The objective of the analysis is to identify market
inefficiencies or distortions in the trading of these instruments which
are conceptually linked to each other. The daily return and volatility of
daily return are the principal variables used in the study. The results
indicate that the instruments exhibit generally consistent price
behavior. However, some distortions due to speculative influence and
operational inefficiency are also seen presumably because of the
innovative nature of the instruments as far as the Indian securities
market is concerned.
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