A Study on the Third-Generation Exchange-Traded
Funds: The Case of Short ETFs

Abstract

In this article, Rompotis investigates the third generation of exchange-traded funds (ETFs) using data from a sample of 37 so-called short ETFs, which seek to achieve two or three times the return of an index in a negative fashion on a daily basis. Various issues concerning short ETFs are examined. In particular, emphasis is given to the ability of these ETFs to meet their daily investment target. In this respect, an average deviation from the daily target amounting to -0.034% is computed. Applying a classification to the deviation from the daily return goal, Rompotis finds that for about 62% of the examined trading period’s duration the return of the average short ETF abstains from its target by a maximum rate of 0.5%, either below or above the target. Regression analysis applied to the deviation from the return target indicates that the lagged deviation is negatively related to the contemporary deviation. The last research issue regards the most profitable investment strategy that can adopted by an investor when deciding to choose from short ETFs, regular ETFs, and a hedging strategy, which invests 50% in short ETFs and 50% in regular ETFs. In any case, investing in regular ETFs is more profitable than the other two strategies. Nevertheless, investing in short ETFs or adopting the hedging strategy can be profitable for a sufficient number of times, thus being appropriate for investors having short-term horizons, while the hedging strategy considered mitigates the investment risk.

TOPICS: Exchange-traded funds and applications, portfolio construction, portfolio theory