Steering a Ship in Illiquid Waters: Active Management of Passive Funds

Naz Koont, Yiming Ma, Lubos Pastor and Yao Zeng

No 30039, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: Exchange-traded funds (ETFs) are typically viewed as passive index trackers. In contrast, we show that corporate bond ETFs actively manage their portfolios, trading off index tracking against liquidity transformation. In our model, ETFs optimally choose creation and redemption baskets that include cash and only a subset of index assets, especially if those assets are illiquid. Our evidence supports the model. We find that ETFs dynamically adjust their baskets to correct portfolio imbalances while facilitating ETF arbitrage. Basket inclusion improves bond liquidity in general, but worsens it in periods of large imbalance between creations and redemptions, such as the COVID-19 crisis.

JEL-codes: G12 G23 (search for similar items in EconPapers)
Date: 2022-05
New Economics Papers: this item is included in nep-dem, nep-fmk and nep-ifn
Note: AP
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Working Paper: Steering a Ship in Illiquid Waters: Active Management of Passive Funds (2022)
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