Bond ETF Trading Profits?

Bond ETF Trading Profits?

August 28, 2013 Research Insights
Print Friendly
(Last Updated On: January 18, 2017)

Predictability in Bond ETF Returns

  • Jon A. Fulkerson, Susan D. Jordan, and Timothy B. Riley
  • A version of the paper can be found here.
  • Want a summary of academic papers with alpha? Check out our free Academic Alpha Database!

Abstract:

We study the persistence of bond ETF premiums and discounts. Following a day of high or low premiums or discounts over NAV, ETFs tend to maintain a premium or discount for up to 30 days. Premiums and discounts also predict distinct patterns of returns after daily closing. Overnight returns are negative following a high premium, while ETFs with large discounts are followed by positive overnight returns. The large discount ETFs have substantially higher returns than high premium ETFs over the subsequent thirty days. We find that traditional liquidity measures, along with prior deviations from NAV, are significant in explaining a fund’s premiums/discounts. Finally, we examine a long-short portfolio strategy to exploit the observed deviations from NAV, and find it generates an alpha of .96% per month or about 11.5% per year.

Data Sources:

CRSP mutual fund database Jan 2007 to December 2011.

Alpha Highlight:

Exhibit 10 shows monthly alpha (bond OLS regression) of 0.96%.

bondetf

Strategy Summary:

  1. Each month, compute each Bond ETF’s Premium/NAV ratio.
    1. Computed as (Price – NAV) / NAV.
  2. Sort into deciles based on this ratio.
  3. Buy the lowest decile of ETFs (lowest Premium/NAV) and short the highest decile ETFs (highest Premium/NAV).
    1. Rebalance each month.
    2. This long/short portfolio has a monthly return of 0.70% (0.94% for long leg and 0.24% for the short leg as shown in Exhibit 9).
    3. Controlling for bond factors (in Exhibit 10), this long short portfolio earns an abnormal return of 0.96% per month.

Commentary:

  • Paper points out that arbitrage may not be a profitable strategy.
  • Paper shows the persistence of these premiums and discounts (measured up to a month as shown in Exhibit 8).
  • Premiums increase if a Bond ETF is illiquid.

Anyone tried this?


Note: This site provides NO information on our value investing ETFs or our momentum investing ETFs. Please refer to this site.


Join thousands of other readers and subscribe to our blog.


Please remember that past performance is not an indicator of future results. Please read our full disclosures. The views and opinions expressed herein are those of the author and do not necessarily reflect the views of Alpha Architect, its affiliates or its employees. This material has been provided to you solely for information and educational purposes and does not constitute an offer or solicitation of an offer or any advice or recommendation to purchase any securities or other financial instruments and may not be construed as such. The factual information set forth herein has been obtained or derived from sources believed by the author and Alpha Architect to be reliable but it is not necessarily all-inclusive and is not guaranteed as to its accuracy and is not to be regarded as a representation or warranty, express or implied, as to the information’s accuracy or completeness, nor should the attached information serve as the basis of any investment decision. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission from Alpha Architect.


Definitions of common statistics used in our analysis are available here (towards the bottom)




About the Author

Wesley R. Gray, Ph.D.

After serving as a Captain in the United States Marine Corps, Dr. Gray earned a PhD, and worked as a finance professor at Drexel University. Dr. Gray’s interest in bridging the research gap between academia and industry led him to found Alpha Architect, an asset management that delivers affordable active exposures for tax-sensitive investors. Dr. Gray has published four books and a number of academic articles. Wes is a regular contributor to multiple industry outlets, to include the following: Wall Street Journal, Forbes, ETF.com, and the CFA Institute. Dr. Gray earned an MBA and a PhD in finance from the University of Chicago and graduated magna cum laude with a BS from The Wharton School of the University of Pennsylvania.