Equity ETFs versus Index Futures: A Comparison for Fully Funded Investors

• DOI: 10.3905/jii.2014.5.2.066
• Publication Date: 2014-08-28T13:02:07Z
• Authors: Ananth Madhavan; Ursula Marchioni; Wei Li; Daphne Yan Du
• Keywords: 0502 economics and business; 05 social sciences

The widespread adoption of exchange traded funds (ETFs) as institutional instruments, tighter trading spreads, and lower fees mean these investment vehicles are increasingly seen by investors as a viable alternative to futures-based exposure. At the same time, the costs of maintaining a given exposure using futures contracts have increased, driven by regulation which has increased capital requirements and which restricts proprietary trading activities. This article 1) summarizes the trade-offs between the use of futures and ETFs for fully funded investors; 2) provides empirical evidence that ETFs are now, in many instances, a lower cost alternative to fully funded futures; and 3) analyses the fundamental drivers of roll mispricing, providing evidence that higher costs for futures reflects longer-run, systematic factors such as regulation that are unlikely to reverse soon.