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The Active World of Passive Investing
[Mutual fund’s R2 as predictor of performance]

Author

Listed:
  • David Easley
  • David Michayluk
  • Maureen O’Hara and Tālis
  • J Putniņš

Abstract

We investigate the new reality of exchange-traded funds (ETFs). We show that most ETFs are active investments in form (designed to generate alpha) or function (serve as building blocks of active portfolios). We define a new activeness index to capture these dimensions, finding that the cross-section of ETFs is now increasingly characterized by highly active investment vehicles. Active-in-form ETFs have positive flow-performance sensitivity, charge the highest fees among ETFs, and have high within-portfolio turnover. Active-in-function ETFs have more concentrated holdings, less within-portfolio turnover, but higher turnover in the secondary market. We show how more active ETFs are gaining market share over less active ETFs, leading to competitive fee pressure both within the ETF space and across the investment management industry. We suggest that the growing activeness of ETFs may assuage concerns about ETFs harming price discovery.

Suggested Citation

  • David Easley & David Michayluk & Maureen O’Hara and Tālis & J Putniņš, 2021. "The Active World of Passive Investing [Mutual fund’s R2 as predictor of performance]," Review of Finance, European Finance Association, vol. 25(5), pages 1433-1471.
    • Handle: RePEc:oup:revfin:v:25:y:2021:i:5:p:1433-1471.
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    File URL: http://hdl.handle.net/10.1093/rof/rfab021
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    Citations

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    Cited by:

    1. Xu, Liao & Pu, Wenyan, 2022. "ETFs, arbitrage activity, and stock market efficiency: Evidence from Chinese CSI 300 ETFs," Economic Analysis and Policy, Elsevier, vol. 73(C), pages 1-9.
    2. Said Kaawach & Oskar Kowalewski & Oleksandr Talavera, 2023. "Automatic vs Manual Investing: Role of Past Performance," Discussion Papers 23-04, Department of Economics, University of Birmingham.
    3. Shiyang Huang & Maureen O’Hara & Zhuo Zhong, 2021. "Innovation and Informed Trading: Evidence from Industry ETFs [Short interest, institutional ownership, and stock returns]," Review of Financial Studies, Society for Financial Studies, vol. 34(3), pages 1280-1316.
    4. Carmine De Franco, 2021. "Stock picking in the US market and the effect of passive investments," Journal of Asset Management, Palgrave Macmillan, vol. 22(1), pages 1-10, February.
    5. Joey W. Yang & Lewis May & John Gould, 2023. "Exchange‐traded fund ownership and underlying stock mispricing," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 63(S1), pages 1417-1445, April.
    6. Marta Khomyn, 2020. "Essays on Modern Market Structure," PhD Thesis, Finance Discipline Group, UTS Business School, University of Technology, Sydney, number 2-2020.
    7. Valadkhani, Abbas & Moradi-Motlagh, Amir, 2023. "An empirical analysis of exchange-traded funds in the US," Economic Analysis and Policy, Elsevier, vol. 78(C), pages 995-1009.
    8. Ewa Feder-Sempach & Tomasz Miziołek, 2023. "How precisely European equity ETFs mirror their flagship benchmarks? Evidence from funds replicating performance of Euro Stoxx 50 Index," Journal of Asset Management, Palgrave Macmillan, vol. 24(2), pages 121-135, March.

    More about this item

    Keywords

    Exchange-traded fund; ETF; Activeness Index; Passive investing; Index investing;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors

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