Lipper Report Shows Profit Opportunity in ETF-Index Deviation

LONDON (HedgeWorld.com)–A new study by fund research provider Lipper finds that exchange-traded funds (ETF) can sometimes deviate from the market indices they are designed to track, providing a profit-making opportunity for market makers. Lipper, which is the parent company of HedgeWorld and a subsidiary of Reuters, examined 21 ETFs in the report.

A significant arbitrage opportunity arises from the price inefficiencies of European ETFs pegged to international indices, the study found. The factors causing this included liquidity; inefficiencies in the creation-unit mechanism; trading-day differences between exchanges; and exchange-rate bias.

“European ETFs tracking international indices that adjust for time zones, trading day differences, and stale prices incorporate index-tracking inefficiencies ascribable to a price-discovery bias, introducing the potential for larger deviations between the two,” said Aureliano Gentilini, co-author of the report and Lipper’s head of research in Europe.

In Europe, ETFs tracking a domestic index and traded on a domestic market display favourable correlation, tracking error, and relative skewness figures when analyzed against their underlying index. The correlation also holds, though to a slightly lesser degree, for products pegged to pan-European indices, domestic indices traded on another European exchange and fixed-income products.

The ETF market has expanded quickly and now counts over 500 instruments covering an asset value of over $450 billion. The funds are run by 53 managers on 33 exchanges.