Тарасов_резюме_ENG (Биржевые фонды (ETF) и скрытые индексные стратегии российских паевых инвестиционных фондов (ПИФ))

National Research University Higher School of EconomicsTarassov Evgeni BorissovitchEXCHANGE TRADED FUNDS (ETF) AND CLOSET INDEXING OF THERUSSIAN MUTUAL FUNDSPhD Dissertation Summaryfor the purpose of obtaining academic degreePhilosophy Doctor in Economics HSEAcademic supervisors:Berzon N.I., Doctor of science (economics);Suvorov A. D., PhDJEL: G11, G23, G41Moscow – 20191According to the Federal Reserve, the United States individual investorshave been reducing direct investments in equity for several decades.1 At the sametime, there is a constant growth in equity investment via open-ended mutual funds.For the US individual investors the open-ended mutual funds, recently alsoexchange traded funds (ETF)2, became the main financial instrument, used formiddle term goals as well as for pension saving purposes.3 Index funds, also calledpassive funds, show the largest increase of market share.

In 2015, the market shareof the equity index fund asset under management (AUM) reached 34%, while in1995 this share used to be only 4% (Bogle, 2016). Due to the rapid technologydevelopment that allows, among others, reducing the index fund management cost,some analysts argue that, latest, by 2024 the market share of passive funds exceedthat of active ones.4The active fund manager needs searching constantly for securities withhighest / lowest growth potential, for the best moments to purchase / sale them inorder to outperform the index return. Moreover, he also constantly monitors thesecurities proportions in fund portfolio to maintain the optimal "risk / return" ratio.1https://www.federalreserve.gov/releases/z1/20140306/annuals/a1985-1994.pdf;https://www.federalreserve.gov/releases/z1/current/annuals/a1995-2004.pdf;https://www.federalreserve.gov/releases/z1/current/annuals/a2005-2015.pdf2ETF (exchange traded fund) is a financial vehicle that assists an investor to gain the returncorresponding to return of the selected index.

In most cases, ETF provide this service even easierand cheaper than index mutual funds (Poterba & Shoven, 2002; Boehmer & Boehmer, 2003;Kostovetsky, 2003; Svetina, 2010 Agapova, 2010). The main difference between an ETF and amutual fund is that shares of exchange-traded fund are listed on the stock exchange, in the sameway as shares of any company.

Investors may trade online in real time. In order to buy (or sell)the mutual fund units an investor needs to communicate the management company in advancewithout knowing the exact price.3https://www.federalreserve.gov/releases/z1/current/annuals/a2005-2015.pdf;http://www.icifactbook.org/ch7/17_fb_ch7#retirement;4http://www.n3d.eu/_medias/n3d/files/PBC_1057026.pdf2The index fund manager does not need either to search for investmentopportunities, nor needs he to think about index outperforming, neither aboutoptimal securities proportion. He knows in advance about his portfolio structure:the shares of all issuers in the same proportion as the companies are included inindex.

Keeping this structure allows the index fund manager to provide investorwith return close to that of the index.It is obvious that fund money management service with active part costssignificantly more than fund service without active option. On developed marketsthe total annual active fund investors expenses, in average, are almost 200%higher: 2.12% for active equity funds and 0.77% for index equity funds (Cremerset al., 2015). In the US, for example, in 2016, active fund fees are about 800%higher: 0.09% for index equity funds of 0.82% for active equity funds annually.5 Inthe case when investor knows which index the fund promises to outperform, it iseasy to assess the past decision whether it made sense to pay for activemanagement or not: one need to compare the index return with net investor’sreturn.

Since 1998, the Securities Commission (SEC) has been requiring the USactive funds to name the index (benchmark), those return the fund plans regularlyoutperforming (Sensoy, 2009).However, the investor is not always aware of all important details choicethat he faces: for example, when a fund simply tracks its benchmark (to a largeextent or completely) without declaring this fact, and keeping its fees on the activefund fee level, investor pays for active money management service withoutrealizing its absence or reduced form. The individual investors behavior who investin mutual funds pursuing the closet indexing (or the closet passive strategies) isresearched in "libertarian paternalism" (Sunstein and Thaler, 2003) frame: ifinvestors' mistakes are expected, we need developing measures to reduce thefrequency of that mistakes.

The “libertarian paternalism” concept is based on thetheory of "bounded rationality" (Simon, 1953).5https://www.ici.org/pdf/2017_factbook.pdf3The objectives of the dissertation research is, firstly, to study the influenceof mutual funds closet indexing on the investor net financial result, and secondly,to propose measures of economic policy aimed at reducing the frequency ofinvestors mistakes related to the closet indexing.Closet indexing is studied on the example of the Russian mutual fund marketthat is only 0.2% of Russia's annual GDP.

In other BRICS countries, this openended mutual funds share of GDP is fundamentally higher: in Brazil - 45.3%, inIndia - 5.7%, in China - 5.2%, in South Africa - 40.7%. In the US, this figurereaches 89.4% (Inozemtsev, Simonov, Goryaev, 2016). On % of GDP, Russia is onthe 64 rank out of 67 (Abramov, Akshentseva, 2015).To identify the mutual funds following the closet index strategies and tomeasure the fund activity level, the Active Share / AS (Cremers and Petajisto,2009) concept may be used. The Active Share concept was successfully used byCremers, Ferreira, Matos, Starks, (2016) to explore the mutual funds in 32countries (including those that do not possess highly developed financial markets,such as Poland).6The Active Share shows how much the fund portfolio deviates from itsbenchmark (index) portfolio; it is calculated as shown in formula 1:1AS = ∑Noi=1 |wfund,i − windex,i |,(1)2where wfund,i and windex,i are weights of company ἰ in the fund and indexportfolios.

The MFs whose Active Share is less than 60%, Cremers and Petajistocall closet indexers.In contrast to the previously studied countries, the closet indexing in Russiais found in two forms: closet indexing of active funds and closet indexing of funds6https://datamarket.com/data/set/28lb/mutual-fund-assets-to-dp#!ds=28lb!2rqc=1s&display=line4of funds, whose portfolio consists of shares of one particular ETF.7 Moreover,there are two particular phenomena related to ETFs on the Russian market. I couldnot find similar examples in other countries.The first phenomenon is the very low level of the ETF market development:the first ETF on the Moscow stock exchange appeared in 2013. This ETF tracksthe Russian corporate bonds broad market (EMRUS; Bloomberg Barclays).8 In2016 the first ETF tracking the broad Russian equity index (RTS) was listed.9The second phenomenon is, on the contrary, the widespread use of theforeign ETFs by Russian mutual fund managers for the mentioned above closetindexing strategy.The fund manager’s action, whose portfolio consists almost entirely of oneETF shares and the fee level is perceived as the active fund fee level I suggest tocall as "implicit indexing"10.

I call the behavior of investors placing their moneyinto such funds as “the Russian ETF paradox”.Survey shows the only one response to the question “why people invest inequity via mutual fund instead of doing it directly” - “because people think thatfund managers are more educated, trained, experienced and have more time tofollow the market to search for the most / least potentially profitable securities andfor the best moments to buy / to sell them”. Moreover, the survey shows that7Several funds-of-funds after my publication about the mutual funds, whose portfolio consists ofshares of only one pre-selected ETF added to their portfolio several other securities included inthe same index that the ETF tracks, or shares of several other ETFs tracking the same index.Thus, their Active Share increased from 2-3% to 5-10% which also corresponds to the criterionof closet indexing.

Moreover, these fund-of-funds portfolio structure differ from those of activefunds that typically do not invest more than 15% in securities of one issuer.8FinEx Russian Eurobonds ETF9FinEx Russian RTS Equity UCITS ETF10Aiming to underline the difference from explicit indexing (classical index mutual fund andETF) and active fund closet indexing.5people are not ready to pay fund for the service if the fund does not conduct thispermanent search. However, during the research period (2014 - 2015), the fundsthat do not conduct this permanent search raised more investors’ money than anyother funds group.Taking into account the Russian market particularities related to ETF, theETF role in closet indexing strategies, and trying to find possible reasons for the"Russian ETF paradox", the first chapter of the dissertation research is devoted tothe review of academic studies on exchange traded funds.When writing the survey, I found only three reviews of ETF academicstudies: Deville (2008), Charupat and Miu (2013) and Madhavan (2014)11.