Editor’s Letter

To open the Winter issue, Laipply and Madhavan show that during the 2020 COVID-19 crisis, bond exchange-traded funds (ETFs) acted as vehicles of price discovery. Also, bond ETFs allowed investors to rapidly and efficiently manage exposure and risk at low costs. Contrary to some academic theories, there is no evidence of “wrong way” arbitrage. Rowley, Wang, and White analyze the relationship between time of day and bid-ask spread for US-domiciled fixed income ETFs with US dollar exposure. The authors find that both before and after they add controls, average spreads are highest in the morning, supporting the argument that investors trading based on NBBO spreads should avoid trading near the market open. After falling from morning peaks, spreads generally flatten out the rest of the day, even after adding controls. Therefore, the analysis does not support the argument that investors should systematically avoid trading US fixed-income ETFs near the market close.

Next, Broby and Spence evaluate the tracking efficiency of physical and synthetic ETFs. They find the total expense ratio remains the pre-eminent explanatory variable but that the type of replication strategy is a significant secondary factor. The authors observe that the counterparty risk in synthetic strategies is not rewarded relative to physical replication strategies. The synthetic ETFs increase tangency portfolios’ returns compared to physical ETFs when analyzed using mean-variance spanning techniques. This suggests investment in synthetic strategies is suited to risk-tolerant investors, and investment in physical strategies is more suited for risk averse investors.

To continue, Hsu, Liu, and Wool examine the most popular investment arguments in favor of a greater allocation to China onshore and offshore equities, as well as skeptical counterarguments to these claims. They present hard data and straightforward empirical tests in response to questions such as China is large in terms of GDP and market capitalization—so what?; and the Chinese stock market is filled with non-professional retail investors but does that lead to greater alpha, and can investors capture that through long exposure to a market with questionable accounting and large differences in regulatory practices? Johansson and Johansson discuss the practical application of a new definition of value and provide both theoretical and empirical evidence of the existence of a disruptive growth stock valuation premium in equity markets. They argue that in the past decade the valuation premium in growth stocks has been the main driver of the outperformance of growth stocks.

To complete this issue, Mooney, Malhotra, and Russell study advisory fees and mutual fund returns. As expenses are a charge against returns to investors, a fund with high fees must perform better than a low-cost fund to generate the same returns. Even small differences in fees can translate into large differences in returns when compounded over time. This study examines whether higher advisory fees results in a superior rate of return for investors.

As always, we welcome your submissions. Please encourage those you know who have papers or have made good presentations on indexing, ETFs, mutual funds, or related subjects to submit them for consideration. We value your comments and suggestions, so please email us at journals{at}investmentresearch.org.

Brian Bruce

Editor-in-Chief

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