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Self-inflating ETFs

Steve LeCompte | | Posted in: Animal Spirits, Mutual/Hedge Funds

Key Insight

Concentrated, illiquid U.S. equity ETFs show a positive flow-return relationship (self-inflation) that explains 8% of monthly return variation for large ones, while broad ETFs show practically none (daily holdings 2019–2023; descriptive).

Do narrow exchange-traded funds (ETF), such as specific technology-focused funds, exhibit a predictable lifecycle of fund inflows that inflate prices of holdings followed by fund outflows that depress prices of holdings? In their May 2024 paper entitled "Ponzi Funds", Philippe van der Beck, Jean-Philippe Bouchaud and Dario Villamaina decompose ETF returns into price pressure (self-inflated) and fundamental components, with the former a function of the concentration of ETF holdings and flows of investor money into and out of the fund. They then compare performances of funds with relatively high and relatively low self-inflated returns. Using daily holdings of U.S. equity ETFs during 2019 through 2023, they find that:

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