Three Essays on Exchanged-traded funds and Institutional ownership

Abstract

The first essay examines the replacement effect of smart beta ETFs on closet-factor active mutual funds. The results show that smart beta ETFs offer factor exposures at lower fees and, therefore, higher risk-adjusted returns than closet factor funds. Investors notice the benefits of smart beta ETFs and replace closet factor funds with these ETFs. Closet factor funds are at higher risks of being replaced when investors are sophisticated, when the market share of smart beta ETFs increases, and after 2012. The findings illustrate the dynamic changes in investor preference towards investment products that bring similar or greater benefits at a lower price.

Actively managed ETFs are new but fast-growing products in the financial markets. The second essay studies whether these funds employ active management and deliver better risk-adjusted returns to the investors than their passive peers. The sample consists of ETFs investing in US equity and international equity from 2008 to 2021. The results suggest that actively managed ETFs investing in US equity, including non-transparent funds, neither significantly differ in their management style nor deliver better risk-adjusted returns to the investors than their passive counterparts. However, there is some evidence of outperformance from active ETFs that invest in international markets. Based on net flows to these funds, active ETF flows do not seem to have a stronger response to the "skill" components of the fund returns, suggesting that flows to active ETFs may not be as "smart" as expected.

The prior literature documents that institutional investors, especially those with large and persistent holdings, play an essential role in the corporate governance of their investee firms. The third essay examines whether institutional ownership stability can enhance product quality management. Using a sample of product recall incidents from 2012 to 2021, we find that firms with more stable institutional investors have a lower probability, frequency, and severity of recall incidents and adopt a proactive product-recall strategy. The findings support the monitoring theory of stable institutional investors that they can effectively reduce product failures, which jeopardize a firm long-term performance and value.