LONDON (HedgeWorld.com)–A new study by fund research provider Lipper finds that exchange-traded funds (ETF) can sometimes deviate from the market indices they are designed to track, providing a profit-making opportunity for market makers. Lipper, which is the parent company of HedgeWorld and a subsidiary of Reuters, examined 21 ETFs in the report.

A significant arbitrage opportunity arises from the price inefficiencies of European ETFs pegged to international indices, the study found. The factors causing this included liquidity; inefficiencies in the creation-unit mechanism; trading-day differences between exchanges; and exchange-rate bias.

“European ETFs tracking international indices that adjust for time zones, trading day differences, and stale prices incorporate index-tracking inefficiencies ascribable to a price-discovery bias, introducing the potential for larger deviations between the two,” said Aureliano Gentilini, co-author of the report and Lipper’s head of research in Europe.

In Europe, ETFs tracking a domestic index and traded on a domestic market display favourable correlation, tracking error, and relative skewness figures when analyzed against their underlying index. The correlation also holds, though to a slightly lesser degree, for products pegged to pan-European indices, domestic indices traded on another European exchange and fixed-income products.

The ETF market has expanded quickly and now counts over 500 instruments covering an asset value of over $450 billion. The funds are run by 53 managers on 33 exchanges.

The study identifies the opportunity that market makers and institutional investors who invest in real-time data and sophisticated software tools should be able to profit from short periods of price inefficiency between ETFs and the underlying indices. It also shows the possibility of anticipating the impact of disturbances in the underlying stock market and information flow, with opportunities to lock in profits through cross-border trading on similar ETFs pegged to the same underlying index.

To view report or contact the authors please see www.lipperweb.com.

BMcIntosh@HedgeWorld.com

Contact Bob Keane with questions or comments at bkeane@investmentadvisor.com.