Episode 268: Itzhak Ben-David: ETFs, Investor Behavior, and Hedge Fund Fees

For nearly 25 years, Exchange Traded Funds (ETFs) have been a popular passive investment vehicle for both household and professional investors due to their low transaction costs and high liquidity. But what are the pros and cons? How can you diversify your portfolio to avoid volatility? Today, we are joined by Professor Itzhak Ben-David, one of the world’s foremost academic experts on ETFs, the Neil Klatskin Chair in Finance and Real Estate at The Ohio State University (OSU) Fisher College of Business, and the Academic Director of the OSU Center for Real Estate. In this episode, we look at the current ETF market and the impact that ETFs have on underlying securities and investor outcomes. We discuss Morningstar ratings, the change that happened in 2002, and some mind-blowing data regarding hedge fund fees. We also dive into the correlation between miscalibrated CFOs and overconfidence; the unnecessary mental accounting people do when it comes to tax refunds, and so much more. This conversation makes for an incredibly diversified overview of a variety of topics that are relevant to financial decision-making at the household level. Finance experts will certainly find value here, too! Regardless of your level of experience, tune in today to learn more.   Key Points From This Episode:   (0:03:27) Professor Ben-David’s take on the current state of the ETF market.  (0:07:37) Ways that investors are affected by a broader variety of ETF options.  (0:16:46) Advice for investors who have been lured in by a sector or thematic ETF.  (0:17:53) Mutual or hedge funds versus ETFs and their impact on underlying securities.  (0:26:38) Reflections on the behaviour of mutual fund investors (learning versus luck).  (0:33:01) How we can learn what investors care about from mutual fund flows.  (0:37:15) Why investors typically put their money where the Morningstar ratings are.  (0:38:46) Morningstar’s rewiring of the “star” system in 2002 and its repercussions.  (0:48:54) The effect of Morningstar ratings on mutual fund flow and momentum.  (0:52:40) Hedge fund investor behaviour versus mutual fund and ETF investors.  (0:54:46) The “two-and-20" hedge fund fee that sets it apart from mutual funds.  (1:00:53) What happens after investors pull their money from a hedge fund after a loss.   (1:02:19) How hedge fund incentive fees correlate with hedge fund performance. (1:04:09) Key lessons for investors who might be considering allocating to hedge funds.  (1:07:15) How people treat tax refunds differently from other income and expenses  (1:13:20) Defining miscalibration and the behavioural bias that overconfidence presents.  (1:19:26) How CFO miscalibration responds to rising market uncertainty (and how to avoid it).  (1:22:58) Professor Ben-David’s definition of success in relation to failure.    Links From Today’s Episode:   Rational Reminder on iTunes — https://itunes.apple.com/ca/podcast/the-rational-reminder-podcast/id1426530582. Rational Reminder Website — https://rationalreminder.ca/  Shop Merch — https://shop.rationalreminder.ca/ Join the Community — https://community.rationalreminder.ca/ Follow us on X — https://twitter.com/RationalRemind Follow us on Instagram — @rationalreminder Benjamin on X — https://twitter.com/benjaminwfelix Cameron on X — https://twitter.com/CameronPassmore Cameron on LinkedIn — https://www.linkedin.com/in/cameronpassmore/ Itzhak Ben-David — https://u.osu.edu/ben-david.1/ Itzhak Ben-David on LinkedIn — https://www.linkedin.com/in/ibendavi/  Financial Markets and Human Behavior - https://bpb-us-w2.wpmucdn.com/u.osu.edu/dist/d/7877/files/2023/08/202308_Rational_Reminder_podcast.pdf ‘Do ETFs Increase Volatility?’ – http://ssrn.com/abstract=1967599 ‘Mutual Fund Flows and Performance in Rational Markets’ – https://ssrn.com/abstract=383061 ‘The Performance of Hedge Fund Performance Fees’ – https://ssrn.com/abstract=3630723 ‘Paper on how people treat their tax refunds’ — https://doi.org/10.1111/j.1540-6261.2007.01232.x ‘Managerial Miscalibration’ — http://ssrn.com/abstract=1640552 ‘The Persistence of Miscalibration’ — https://ssrn.com/abstract=3462107