Investor Sentiment and Global Exchange Traded Funds
By Dr. Gulfem Bayram —
The exchange traded funds (ETFs) are securities that track stock indexes, commodities, or baskets of assets, and they are traded on stock markets just like individual stocks. These unique securities have become increasingly popular in recent years as they offer greater diversity and flexibility for individual investors.
Rapid Growth of ETFs
Given their appeal, the demand for ETFs has grown and continues to grow very rapidly, attracting $775 billion in net inflows in 2013 compared to a net outflow of $81 billion for mutual funds. While there are a variety of ETFs, those with a global flavor that invest in various national stock markets have been especially popular, as they are believed to provide protection against country-specific risks. In some of my own recent research; however, I have come to question the validity of the argument that global ETFs are a good protection against individual country risks. In other words, I have found that the global ETFs are sensitive to the investor sentiments in different countries.
Investor Sentiment
In order to find answers to these questions, first we need to understand what investor sentiment is. Briefly, we can define investor sentiment as the overall belief about the future cash flows and investment risks that is not justified by facts and data on hand. The traditional finance theories do not even consider investment sentiment as a risk factor in asset pricing. In fact, if we dig into models like Capital Asset Pricing, Rational Expectations Theory, and Efficient Markets Hypothesis, we observe that their common assumptions are “rationality” and “wealth-utility maximization” characteristics of investors.
Irrational Behavior
Some milestone studies in finance acknowledge the possibility of irrational behavior in stock markets as referring to the potential impact of these behaviors on stock prices as “noise.” However, these studies fail to consider irrational consumer behavior in the stock markets as one of the significant risk factors in asset pricing models. To them, “noise” can exist in the stock markets but such noise would not affect the long-term path of the equity prices. Thanks to advances in behavioral finance studies, we now know that indeed these irrational behaviors, beliefs, emotions, and feelings do impact stock prices significantly and they no longer should be treated as complete noise.
A Closer Look
In the light of the above studies, I examined the impact of individual country investor sentiments on global ETFs and their immunity to these sentiments; I collected monthly pricing data for the most popular global ETF in the NYSE, namely, Ishares Global 100 ETF, between the years of 2000 and 2013. This particular global ETF contains equities from United States, United Kingdom, Germany, France, Switzerland, and Japan. Also using monthly investor sentiment data from each of these countries, my analysis revealed an interesting answer to my questions: when you buy a global ETF, the returns from your basket of securities will not be immune to country specific investor sentiment risk.
For my sample, I found that the French investor sentiment on where the overall economy and market is headed did have significant impact on the Ishare Global 100 ETF returns. Therefore, investors who buy global ETFs, thinking that they would be protected against country specific investor sentiment risks, will be in for a big surprise.
Gulfem Bayram, Ph.D.
Cameron School of Business, Assistant Professor of Finance