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Active mutual funds: Beware of smart beta ETFs!

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  • Le, Thanh Dat

Abstract

Smart beta ETFs have gained tremendous prevalence among investors in recent years. This study provides empirical evidence that a proportion of this fast-paced growth can be attributed to the investor migration from closet factor active mutual funds to smart beta ETFs. Using a sample of US domestic equity active mutual funds and smart beta ETFs from 2000 to 2019, we find that smart beta ETFs offer factor exposures at lower fees and therefore higher risk-adjusted returns than closet factor funds. The investors notice the benefits of smart beta ETFs and replace closet factor funds with these ETFs. Closet factor funds are at higher risks of being replaced when investors are sophisticated, when the market share of smart beta ETFs increases, and after 2012. Our findings illustrate the dynamic changes in investor preference towards investment products that bring similar or greater benefits at a lower price.

Suggested Citation

  • Le, Thanh Dat, 2023. "Active mutual funds: Beware of smart beta ETFs!," Global Finance Journal, Elsevier, vol. 56(C).
    • Handle: RePEc:eee:glofin:v:56:y:2023:i:c:s1044028322000400
    DOI: 10.1016/j.gfj.2022.100738
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    Keywords

    ETFs; Mutual funds; Active mutual funds; Smart beta ETFs; Replacement; Factor investing;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors

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