Tail-Risk Hedging, Dividend Chasing, and Investment Constraints: The Use of Exchange-Traded Notes by Mutual Funds

Abstract

Our study examines mutual fund demand for a newly designed security, exchange-traded notes (ETNs). We find strong evidence that mutual fund long positions in ETNs significantly underperform and that the motivations to hold ETNs lie outside of maximizing returns. Mutual funds hold ETNs to hedge tail risk and to gain access to higher dividend yields. Mutual funds have a strong preference for derivative-like ETNs although this preference is unrelated to contractual constraints. Finally, we show that skilled timing of ETN investments is limited to the short-sales market.

Keywords: Exchange Traded Notes, Mutual Funds, Financial Innovation, Portfolio Management

JEL Classification: G11, G23, G20