Examine the effect of investor sentiment on JSE ETFs under changing market conditions

Abstract

ETFs have become popular as an investment tool both globally and in South Africa. The exponential growth in popularity of ETFs and assets under management over the last three decades has solidified ETFs as an essential component of many investors' portfolios. Investors with low sentiment often exhibit greater caution and risk aversion, while investors with high sentiment typically have a more optimistic view and an eagerness to take on risk in response to shifting market conditions. When the economy is growing, high sentiment investors like to buy more ETFs to take advantage of the expansion, while low sentiment investors typically sell their ETFs on the exchange in order to reduce their exposure during recessions. Furthermore, investor behaviour during these times of market volatility may raise questions about the stability of the ETF market, which would detract from the attractiveness of ETFs and encourage investors to steer away from them. The primary objective of this research study is to determine the effect of investor sentiment on JSE-listed ETF returns under changing market conditions. The study followed a quantitative methodology using secondary data in answering the primary objective. The secondary data was collected from the McGregor BFA database and consisted of monthly closing prices of seven JSE ETFs and an investor sentiment index. A time series analysis was used for the converging period from October 2008 to December 2023. For a more complex understanding of how sentiment evolved and influenced market regimes, the Markov regime-switching model was integrated with Principal Component Analysis. The results of this research study found that investor sentiment had a significant impact on most of the ETFs in both the bull and bear market conditions, and both market conditions had a few insignificant impacts on the ETF returns. It was also found that the bull market condition was more dominant across the ETF returns. The findings showed that investor sentiment does affect the returns of ETFs on the JSE. Identifying the effect of investor sentiment on ETFs will result in ETF portfolios being less affected by changing market conditions by using risk management techniques and diversifying across asset classes and investing methods. The main contribution of the study lies in the understanding of how investor sentiment interacts with ETFs in times of fluctuating market sentiment under changing market conditions. As ETFs become more popular among investors because of their ease of use, affordability, and liquidity, this field of study becomes more important. It is important to understand how investor sentiment affects the volatility of ETFs since changes in sentiment can magnify market movement and increase ETF return volatility. As ETF products continue to offer diversification, and more investors engage in the market, these insights are important for the management of risk in the ETF market. The study underlines the factors behind the heightened sensitivity of ETFs to sentiment-driven behaviours, which are usually more apparent during times of volatile markets. The immediate fluctuation in prices of ETFs can be caused by investor sentiment, which can cause significant inflows and outflows of investments during periods of increased uncertainty or abrupt market changes. Therefore, it is essential to comprehend these sentiment-driven fluctuations in order to forecast possible risks related to ETFs in different market situations. To the author's knowledge, no other research study has examined how investor sentiment affects ETF returns in the South African context. This study has added a significant component to the behavioural finance literature in South Africa. By examining the effect of investor sentiment on ETF performance, this study significantly adds to the knowledge of how behavioural factors affect investments in the South African market. The limitations of this study, as well as the introduction and background, open the door for further improvements of future research, and future studies can expand the dataset to include both international and domestic ETFs. Given that this research used an indirect measure, market-based metrics, future studies can incorporate different investor sentiment indexes or a different method to calculate investor sentiment, such as direct approaches like survey measures, or a more modern strategy like gathering information from online sources.