Экономические науки/ Инвестиционная деятельность и фондовые рынки

Taras Kucher

Deputy head for stock market operations at KINTO

Ph.D. student at Kyiv National Economic University named after Vadym Hetman

Exchange traded funds on Ukraine stock market: developments and implications

One of the most important elements of the Ukrainian stock market development is the innovative financial instruments introduction that would become effective infrastructure elements. The effectiveness of innovative instrument reflects pent-up demand among institutional and private investors, which will be carried out after the implementation of this instrument. Pent-up demand is based on existing but not implemented strategies in the stock market due to lack of appropriate instrument. One of this effective infrastructure may be Exchange Traded Funds (ETF). ETF - an investment fund whose securities are traded intraday on stock the exchange at market-determined prices [1, p. 2].

Despite the ETF industry significant growth and their interest among institutional and private investors in the global stock market it hasn’t generated a research interest among western and domestic scientists. Some theoretical and practical aspects of the exchange funds investigated Bernstein, which defined the concept of the ETF, has shown his place in the financial market, defined tax advantages over mutual investment funds. Gastineau analyzes ETF’s characteristics and operating principles. Many studies have been performed on Exchange Fund SPDR such scholars as Poterba and Edwin. Kostovetsky made a deep comparative analysis between the ETF and index mutual funds and show up main ETF’s advantage, which was lower administrative and operating expenses and tax efficiency in the U.S. stock market. Lasser demonstrated the relation between ETF and index futures pricing. Lei Yu showed that a significant amount of information on share price appears on the ETF market. It means, that ETF market is a component of pricing information efficiency on the stock markets.

ETFs allow investors to reach their desired markets through tracking indices covering different investment categories: equity indices from developed markets and emerging markets, equity indices representing market sectors, style equity indices (e.g., mid cap, value, growth, etc.), bond indices, liquidity indices, commodities indices, indices relating to real estate companies or private equity, etc. Generally, 73% of ETF’s is based on the stock index, 27% - accounts for funds from other underlying assets.

[2, p.2].

ETF has a number of fundamental advantages that make it highly effective financial instrument. These advantages, we believe, include:

- transparency (ETF using passive investment strategy and form a portfolio of predefined index included securities);

- flexibility (investors use ETF for day-trading and long-term investment planning. Stock exchange presence makes ETF possible to use margin to open long and short positions);

- low cost (passive management and stock exchange listing makes ETF low-cost investment instrument such as no management fee and significant commission for stock exchange bay/sell operations );

- diversification (ETF have a wide portfolio of securities that substantially reduces issuer risk) [2, p.5];

In early 2011, the assets of ETF’s were more than 1 trillion dollars, and their number reached 2115. Thus, for industry 10 years assets of ETF’s increased tenfold. [3, c.2] According iShares, in the end of 2012 assets of ETF will grow to $ 2 trillion dollars. The largest by assets ETF on the S & P 500, which is called the SPDR (Standard & Poor's depository receipt). Size SPDR assets in 2011 reached 78.6 million. [4, p.2] SPDR daily average trading volume reached 364 million. [3, c.5].

In March 2011, Ukrainian financial industry created the first index ETF for UX index – «Index Ukrainskoi birzhi» (KUBI). March 29 launched the auction for this instrument. For the 2011 average daily trading volume was 1,05 mln. UAH with 179 average number of transactions, which means significant interest from investor to this instrument. [6].

- «buying the market" (investors, with ETF investing get a package of securities that fits the selected index stocks, which represent the Ukrainian stock market.. "Buy the market" strategy is one of the main advantages of index ETF. In particular, Blake, Malkiel and Gruber showed that active portfolio management, on average, does not offer investors a higher return than the stock index.

- arbitrage transactions between ETF and futures (if the market futures price deviates from its theoretical price up, investors can sell futures and buy the ETF, while receiving income form spread between market and theoretical futures price, and vice versa). The presence on the Ukrainian financial market index futures without spot market doing arbitrage operations very difficult and costly. Run ETF, which serves as a spot asset, made arbitrage opportunities that will be certainly implemented institutional and private investors in the near future;

- synthetic portfolio (ETF allows investors to construct a wide variety of portfolios, using ETF as a core and buying or selling certain additional shares).

- hedging (in the presence of a wide portfolio of shares, investors can protect themselves from losses in the bear market, selling ETF, instead of selling the whole portfolio);

- spread trading between ETF and Stock (if the dynamics of individual stocks significantly deviates from the market dynamics and investor sees the prospect of a narrowing of the rejection, he can sell short the stock and simultaneously buy the ETF (or vice versa, buy ETF and sell share depending on reject up or down). Spreads trading can be profitable even in times of market downturn.

Consequently, the ETF is a highly effective financial instrument with a large number of advantages compared with mutual investment funds and individual stocks. ETF can design different strategies for private and institutional investors. Thus the appearance of ETF on the Ukrainian stock market will expand its infrastructure component that will create the foundation for its future development and increased financial resources from Ukrainian and international investors.

References

1. Robert Engle, Debojyoti Sarkar, 2002. Pricing Exchange trade funds, NYU Stern School of Business.

2. Dott. Aliona Lupu, 2009, Modelling Liquidity Risk of Exchange Traded Funds, Department of Mathematics and Statistics The University of Napoli “Federico II”

3. Discover the benefits: an introduction to iShares ETF, BlackRock, 2010.

4. SPDR S&P 500 ETF Trust Prospectus January 26, 2011

5. John Haslem Exchange-Traded Funds: Nature Developments, and Implications, 2006, Smith School of Business, University of Maryland.

6. Ukrainian Exchange: http://www.ux.ua.