How Long Might an Active Bond ETF's 'Best Ideas' Outperformance Window Last?

12 Pages Posted: 10 Jun 2014

Date Written: June 8, 2014

Abstract

One reason to launch an active bond ETF is a manager’s belief that an opportunistic fund might be able to exploit highly attractive pockets of opportunity buried in the recesses of an existing large and successful bond mutual fund. As a result, a “best ideas” focused active bond ETF could outperform its “parent” strategy. However, there is an interesting nuance. As an ETF’s assets rise, relative to those of its “parent” mutual fund strategy, its outperformance potential should at some point converge to zero. In fact, given the limited evidence that exists so far, the outperformance potential may fall to zero when an ETF has as little as 2% of the assets of its “parent” fund. There are at least four important implications: 1) the outperformance potential is greatest when an active bond ETF is first launched, 2) higher ETF total returns may be associated with lower average “investor returns”, relative to a "parent" strategy, 3) the greater the skill of a manager, and the capacity of a strategy, the greater the opportunity for outperformance persistence, and 4) all other things equal, the returns of a "newer" active bond ETF will generally be greater than the returns of an "older" active bond ETF.

Keywords: active bond ETF, active bond mutual fund, parent strategy, investor return, return gap, best ideas, you snooze you lose

JEL Classification: G10, G11, G12, G15, G28, E58, N20

Suggested Citation

Erb, Claude B., How Long Might an Active Bond ETF's 'Best Ideas' Outperformance Window Last? (June 8, 2014). Available at SSRN: https://ssrn.com/abstract=2447432 or http://dx.doi.org/10.2139/ssrn.2447432

Claude B. Erb (Contact Author)

TR ( email )

CA 90272
United States

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