The Active World of Passive Investing
Western Finance Association (WFA) Annual Meeting (2018)
35 Pages Posted: 27 Jul 2018 Last revised: 15 Jun 2019
Date Written: July 29, 2018
We investigate the new reality of exchange-traded fund (ETF) investing and the impact it has on the overall activeness of the market. We argue that, just as many active investment vehicles are “closet indexers”, many ETFs are active investments in both form and function. We extend the Berk and Green (2004) model to include ETFs and show how skill and scale influence their size and return in equilibrium. We find that most ETFs are highly active with a median active share of 93.1% and median tracking error of 8.8% p.a., relative to the passive market portfolio. We find that more active ETFs are gaining market share at the expense of less active ETFs, whereas the opposite is true for mutual funds. We also show that the market overall is not considerably more passive, and that informational efficiency of the market is not being negatively affected.
Keywords: exchange traded fund, ETF, active share, passive investing, index investing
JEL Classification: G11, G14, G23
Suggested Citation: Suggested Citation