The interplay between investors' demand and providers' incentives has shaped the evolution of exchange-traded funds (ETFs). While early ETFs offered diversification at low cost, later ETFs track niche portfolios and charge high fees. Strikingly, over their first five years, specialized ETFs lose about 30% in risk-adjusted terms. This underperformance cannot be explained by high fees or hedging demand. Rather, it is driven by the overvaluation of the underlying stocks. Overall, providers appear to cater to investors' extrapolative beliefs by issuing specialized ETFs that track attention-grabbing themes.
Ben-David, Itzhak and Franzoni, Francesco A. and Kim, Byungwook and Moussawi, Rabih, Competition for Attention in the ETF Space (December 30, 2021). Fisher College of Business Working Paper No. 2021-03-001, Charles A. Dice Center Working Paper No. 2021-01, Swiss Finance Institute Research Paper No. 21-03, Available at SSRN: https://ssrn.com/abstract=3765063 or http://dx.doi.org/10.2139/ssrn.3765063
