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Dispatches Exchange-Traded Funds

Newer Niche ETFs Underperform Compared to Their Older Index Counterparts

Specialty exchange-traded funds (ETFs) lose approximately 30% of their value over a post-launch period of five years.

by Andrew Gomes | November 2023

Specialty exchange-traded funds (ETFs) lose approximately 30% of their value over a post-launch period of five years.

This finding is based on a study that examines two industry trends: the first ETFs were cost-effective broad-based products meant for diversification; more recently, the landscape has favored pricier specialized ETFs that focus on trendy but often overvalued themes, which typically deliver mediocre performance.

Researchers examined the impact of the industry evolution from index ETFs to specialized ETFs on performance by forming 60 portfolios in the two ETF types based on their launch dates. The time period covered was 2000 to 2019, and portfolios were rebalanced monthly based on ETF market capitalization. The sample included a wide range of U.S. equity market-traded ETFs, grouped into broad-based ETFs tracking comprehensive market indexes and specialized ETFs with a narrower focus.

Performance of ETFs Around Launch

The analysis revealed the dynamics within the two product groups regarding investor sensitivity to fees and past performance. A significant disparity between these two groups was observed. Broad-based ETF investors showed notable sensitivity to fees, while specialized ETF investors appeared more influenced by past performance metrics.

The researchers attribute the disappointing performance of niche ETFs to overvalued stocks held in the funds at the time of launch. Newly launched niche ETFs often consist of securities from attention-grabbing market segments, including stocks with recent price surges, substantial positive media attention, favorable earnings surprises and characteristics associated with overvaluation. Additionally, specialized ETFs tend to cater to preferences for high-risk investments, including securities with skewed returns.

Source: “Competition for Attention in the ETF Space,” by Itzhak Ben-David, Francesco Franzoni, Byungwook Kim and Rabih Moussawi; Fisher College of Business, October 2022.

Discussion

ROBERT A from NC posted over 2 years ago:

This exposes the danger of always chasing the "shiny new thingy." Back after Covid had ravished a lot of tech stocks, I put some "play" money into the new ARK ETFs. For six months or so they were flying! And then they didn't. I think it was an AAII Journal article that finally brought me back to my fundamental senses in time to keep from going into the loss column.


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