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THE RELATIVE PERFORMANCE OF EQUITY INDEX ETFs
AND EQUITY INDEX MUTUAL FUNDS


Zakri Y. Bello
Central Connecticut State University


 

ABSTRACT

Empirical evidence relating to the performance of ETFs is mixed. The mainstream findings are that equity-index ETFs underperform both their benchmark index and equity-index-mutual funds. It is generally reported that ETFs have lower tracking errors, lower expense ratios, and higher brokerage commissions than mutual funds. Previous studies also suggest that the ETF industry has undergone significant changes since 2000, concerning ETF costs and the elimination of the primary causes of ETF underperformance.
The purpose of this study is to reexamine the performance of equity-index ETFs using a relatively larger sample and a longer study period. I find that, during the 2001 to March 2012 period, equity-index ETFs outperformed both equity-index-mutual funds and the S&P 500 index. I used two measures of investment performance—one that assumes a perfectly diversified portfolio and another that does not involve such assumption. The two measures of investment performance provide similar signals.

Moreover, I find that equity-index ETFs have lower expense ratios, lower portfolio turnover, and smaller portfolio holdings compared with equity-index-mutual funds. Also, equity-index ETFs invest 35% of their portfolios in the top-ten stocks they held, compared with 19% for equity-index-mutual funds—all of which suggest that, on average, ETFs are less diversified than equity-index-mutual funds.

Keywords: ETFs, Index Funds, Investment Performance, Portfolio Turnover, Expense
Ratios, Investment Company Act

JEL Codes: G11, G12, G14, G23