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The Active World of Passive Investing*

Mutual fund’s R2 as predictor of performance

David Easley, David Michayluk, Maureen O’Hara and Tālis and J Putniņš

Review of Finance, 2021, vol. 25, issue 5, 1433-1471

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.

Keywords: Exchange-traded fund; ETF; Activeness Index; Passive investing; Index investing (search for similar items in EconPapers)
JEL-codes: G11 G14 G23 (search for similar items in EconPapers)
Date: 2021
References: Add references at CitEc
Citations: View citations in EconPapers (17)

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