Written by: Douglas Cumming, Pedro Monteiro

Abstract

This paper examines the causes and consequences of hedge fund investments in exchange traded funds (ETFs) using U.S. data from 1998 to 2018. The data indicate that transient hedge funds and quasi-indexer hedge funds are substantially more likely to invest in ETFs. Unexpected hedge fund inflows [outflows] cause a rise [reduction] in ETF investments, and the economic significance of unexpected flow is more than twice as large for transient than quasi-indexer hedge funds. Expected hedge fund flows are statistically unrelated to ETF investments on average. When ETF investment is accompanied by an increase in unexpected flow, hedge fund alphas are higher. When ETF investment is accompanied by an increase in expected flow, hedge fund alphas are lower. The data are consistent with the view that hedge fund ETF investment unrelated to unexpected flow is an agency cost of delegated portfolio management.

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