Brian J. Henderson

An Empirical Analysis of Exchange-Traded Funds

Exchange-traded funds (ETFs) provide investors with a single, tradable security for gaining exposure to an index that presumably proxies for an asset class. In the U.S. alone, ETF assets under management have grown to nearly

Monetary Policy and Interest Rate Factors

900 billion. Buetow and Henderson analyze ETF returns to evaluate how closely ETF prices replicate exposures to their benchmark indices. The authors’ analysis highlights practical considerations that influence index replication. On average, an ETF closely tracks its benchmark index. An ETF that tracks an index composed of less liquid securities exhibits a larger tracking error, and an ETF that tracks an index composed of less liquid, or non-U.S., securities exhibits a greater correlation (relative to the benchmark index) with a U.S. equity index, suggesting that the diversification benefits of these ETFs are less than is implied by the return properties of the benchmark index.

An Empirical Analysis of Non-Traded REITs

Previous research establishes the stylized fact that bond returns differ across monetary policy regimes. Specifically, bond returns are higher (lower) and exhibit lower (higher) standard deviations during expan-sive (restrictive) policy periods. Using the three factors known to explain bond returns, we find that the level and slope factors drive the pattern documented in the literature. We find, however, that this pattern is not present in recent data. Our results suggest that either the linkage between monetary policy and bond returns changed or that the association documented in the extant literature arose spuriously.

Pre-Trade Hedging

Non-traded real estate investment trusts (REITs) are registered investment companies formed for the purpose of investing in real estate and marketed to retail investors. Unlike traded REITs, non-traded REITs do not trade on an exchange. We find average annual returns of 4.0% to 89 non-traded REITs, compared to 11.3% average returns over the same period to traded REITs. The economic magnitude of the underperformance exceeds

Shorting Fees, Private Information, and Equity Mispricing

44 billion. A significant portion of non-traded REITs’ underperformance results from high upfront fees and expenses, which average 13.2% and largely serve to compensate brokers. The remainder of the underperformance is due to conflicts of interest that permeate the issuance and management of non-traded REITs. These conflicts include transactions with affiliated parties, such as the high fees paid to external advisors and property managers affiliated with the sponsor. We find significant reductions in expenses after non-traded REITs list their shares. Non-traded REIT investors suffer from the lack of monitoring and effective mechanisms for shareholder protection, such as the formation of block holdings.

The VIX Futures Basis: Determinants and Implications

We find evidence consistent with previously unrecognized market manipulation by broker-dealers. Specifically, we show that pre-trade hedging, which is distinct from front-running, alters prices at which derivative trades occur. We document that this behavior is intentional by exploiting variation in the design of structured equity products (SEPs). We find positive abnormal returns on the SEP pricing dates for which the issuer benefits from altering closing stock prices, but no such returns on pricing dates of otherwise similar SEPs. We also show large-buy trades near close of trading are more frequent when SEP issuers have incentives to alter closing stock prices.

Do Municipal Bond Markups Reflect Accounting Quality

Decomposing lending fees into predicted (fair) and residual (premium or discount) fees reveals overpricing among a third of hard-to-borrow stocks: those for which borrowers pay a premium. Despite paying the highest fees, they are the only profitable shorters. Their net annualized profits of 5% reveal informed shorting. We also document smart lending. Lenders appear attuned to lending-market conditions, discounting fees on stocks with elastic shorting demand, thereby increasing revenues. Stocks with the most discounted fees attract the highest short interest, yet are predominantly easy-to-borrow. Their short sellers do not generate net shorting profits or appear motivated by private information.

Are Flows Costly to Etf Investors

After the Chicago Board Option Exchange’s (CBOE) introduction of VIX futures contracts, and the subsequent introduction of exchange-traded products for volatility investing, investors have allocated non-trivial portions of their portfolios to volatility-linked investments. Since 2003, when significant changes were made to the VIX methodology, the CBOE has asserted that the VIX methodology provides a script for replicating volatility exposure using SPX options. The authors of this article find that, to the contrary, significant option market frictions, particularly among out-of-the-money put options, result in significant barriers to replicating this exposure. They connect option market frictions to changes in the VIX futures basis and find that market information from the most illiquid options is reflected in the VIX, but often not in VIX futures. Because investors frequently advance tail risk hedging as the main portfolio benefit of volatility exposure, the fact that out-of-the-money put option innovations drive the VIX futures basis suggests that, in practice, VIX futures do not provide the desired tail risk hedge.

World Markets for Raising New Capital

We examine whether accounting measures of information uncertainty – specifically, the presence of internal control problems – impact municipal bond markups. Markups are the differences between the prices paid by investors and those stipulated in the underwriting agreement, and are a source of compensation to bond dealers. Markups are controversial in part because they are not transparent and individual investors comprise a large portion of the investor base. Primary findings suggest that municipal bonds issued by entities with a material weakness in internal controls exhibit larger markups. Findings are magnified under circumstances of greater information asymmetry between issuers and investors, such as for revenue bond issuances, delayed release of financial information, and retail investor trades. Moreover, bonds issued by entities with material weaknesses remain in dealer inventory significantly longer before eventual sale to investors. Our evidence is consistent with markups reflecting compensation to underwriters for the additional risk and effort involved in placing bonds issued by entities with serious accounting problems.

The dark side of financial innovation: A case study of the pricing of a retail financial product.

Authorized participants create and redeem exchange-traded fund (ETF) shares in response to supply and demand imbalances in the secondary market. For the majority of ETFs, share creations and redemptions take place as in-kind transactions, but a growing number of ETFs feature cash creations and redemptions. The authors investigate whether ETF flows are costly to investors. Using a reasonable proxy for the potential cost of fund flows, they find evidence of underperformance associated with flows to ETFs featuring cash creations and redemptions and tracking international benchmarks. Because ETF flows do not predict subsequent returns and the authors do not find evidence the funds are susceptible to market-timing strategies, the costs likely stem from the transaction costs associated with the portfolio trades that are necessary to accommodate cash liquidity.