Can exchange traded funds be used to exploit industry and country momentum?

There is overwhelming empirical evidence on the existence of country and industry momentum effects. This line of research suggests that investors who buy country and industry portfolios with relatively high past returns and sell countries and industries with relatively low past returns will earn positive risk-adjusted returns. These studies focus on country and industry indexes that cannot be traded directly by investors. This raises the question of whether country and industry momentum effects really can be exploited by investors or whether they are illusionary in nature because they exist only on non-tradable assets. We analyze the profitability of country and industry momentum strategies using actual price data on exchange traded funds (ETFs). We find that over the sample periods during which these ETFs were traded, an investor would have been able to exploit country and industry momentum strategies with an excess return of about 5 % per annum. These returns cannot be explained by unconditional exposures to the Fama-French factors. The daily average bid-ask spreads on ETFs are substantially below the implied break-even transaction cost levels. Hence, we conclude that investors who are not willing or able to trade individual stocks may use ETFs to benefit from momentum effects in country and industry portfolios.

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