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EghtesadOnline: In a study on the performance of exchange-traded fund, the Tehran Stock Exchange explored the popularity of the financial instrument in the world and reflected on the stumbling blocks on the way of ETFs in Iran’s capital market.

An ETF is a type of fund that owns underlying assets (shares, stocks, bonds, oil futures, gold bullion, foreign currency, etc.) and divides ownership of those assets into shares. 

Data indicates that since inception in 1990, the value of ETF assets across continents reached $4 trillion by April 2017 and exceeded $5 trillion by the end of January 2018, indicating their increasing popularity in the world. 

The US has the biggest ETF market in the world, holding 71% of the total value of ETF assets followed by Europe and Japan which hold 17% and 6% respectively, Financial Tribune reported.

Delving into drawbacks of ETFs in Iran, TSE said the fund’s performance fall far short of expectations despite the fact that on the global and regional level they continue to expand both in value and variety. 

While data indicates a burgeoning trend in Iranian ETFs, their growth has been insignificant compared to mutual funds. The ratio of value of ETFs to mutual funds indicates a downward trend since 2014. In the first month of the current Iranian calendar (March 21-April 20, 2018), the value of ETFs was less than 2% of the value of mutual funds. 

TSE ascribes the shortcomings to a variety of factors, namely a huge gap between net asset value and the closing price, lack of after-hours trade in the capital market, ETFs not being indexed, exchanging creation and cancellation units in cash instead of bartering plus problems related to market making.  

The report indicates a huge gulf between the closing price and NAV in ETFs. For about 22% of the total trading days during 2014-17, the difference was above 2%. In addition, for 61% of trading days, the figure fell above 1%. The gap even exceeded 7% in some trading days during the period under review. 

NAV represents the net value of an entity and is calculated as the total value of the entity’s assets minus the total value of its liabilities. 

This is while the market maker in ETFs were expected to attempt to draw the two prices close together and as with most pioneering capital markets in the world, lower the difference to zero. 

TSE attributes the flaw to the market making contracts according to which the market makers’ quotation difference may range up to 5%.  Therefore, the market maker will be able to make a good profit on quotation differences. 


Promoting Competition 

In addition, the TSE survey showed that out of the eight studied ETFs, 7 were following a similar market making paradigm. It called for creating a more competitive market making environment to allow for a variety of market makers compete for a particular ETF. 

“The weak performance of the market makers due to lack of competiveness ensures their monopoly in the market that ultimately foils attempts to shrink the differences.”

Likewise, lack of after-hours trading for most indexed ETFs in the capital market makes it difficult for tracking indexes.  According to the report, for all the reviewed stock markets, there are after-hours trades at the end of the trading days in which shares are traded at the closing price.  After-hours trading has the merit of attracting the group of dealers who wish to avoid the risk of daily volatility in equity prices.  

After-hours trading is the period of time after the market closes when an investor can buy and sell securities outside of regular trading hours. Trades during after-hours session can be completed through electronic exchanges. 

The fact that most ETFs in the domestic capital market are non-index is another drawback with such funds. Only 2 out of 16 active ETFs in the country are indexed, and in terms of value, index fund accounts for only 3% of the total value of the funds. This is while the number of index funds in US capital market is ten times higher than the non-index peers.

The meager share of indexed ETFs is attributed to the market makers’ weak performance in offering appropriate quotations for creation and redeeming funds’ units. 

Another problem with Iranian ETFs is their lack of “in-kind” trading of creation and redemption of units. Bartering the creation of ETF units with their redemption obviate the need to transfer money between market maker and the fund, which, the report says, facilitates the  payment settlement process. Also, in this way the fund manager will be able to keep an appropriate composition of the basket of shares. 

In short, creation and redemption of ETF units refer to the process of buying new shares for the ETF portfolio and selling them when necessary. 

Finally, the report reckons a big difference between buying and purchasing quotations by ETF market makers as yet another shortcoming with this financial instrument.  Pointing that the quotation gap between purchasing and buying prices are very subtle in most developed stock markets in the world. 

The SEO says the maximum difference between purchasing and buying quotations is 0.05% for ETFs with assets over $50 million and 0.25% for ETSs with less than $10 million.

This is while the maximum range of market makers quotations extends much broader for Iranian ETFs which drives up trading expenses and impedes liquidity growth.   


stock exchange Tehran capital market ETF exchange-traded fund