Hedge Fund Investment in ETFs

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 and quasi-indexer hedge funds are substantially more likely to invest in ETFs. ETF investment is in general associated with worse hedge fund returns, consistent with agency costs. However, some hedge funds invest in ETFs when there is an abnormal increase in capital flow relative to past performance. ETF investment associated with abnormal inflow does not appear to be an agency cost of delegated portfolio management.