Time-varying Alpha Opportunities and the Growth in Passive Fund Management

53 Pages Posted: 26 Apr 2021 Last revised: 26 May 2022

See all articles by Jeffrey A. Busse

Jeffrey A. Busse

Emory University - Department of Finance

Kiseo Chung

Texas Tech University - Area of Finance

Badrinath Kottimukkalur

George Washington University

Date Written: April 24, 2021

Abstract

During the last decade, the U.S. mutual fund industry experienced an unprecedented movement toward passive investments. We tie this shift to underperformance in active funds stemming from a reduction in alpha opportunities. As alpha opportunities decrease, performance predictors like Active Share and R-squared lose their effectiveness, and performance fails to persist. Moreover, the relation between alpha and fund costs turns significantly negative, investor outflows become more sensitive to poor performance, and passive funds see higher inflows. These findings are consistent with outperformance of mega cap stocks reducing alpha opportunities and a subsequent increase in the market share of passive funds.

Keywords: mutual funds, passive investing, performance persistence, flow performance relationship

JEL Classification: G23

Suggested Citation

Busse, Jeffrey A. and Chung, Kiseo and Kottimukkalur, Badrinath, Time-varying Alpha Opportunities and the Growth in Passive Fund Management (April 24, 2021). Available at SSRN: https://ssrn.com/abstract=3833523 or http://dx.doi.org/10.2139/ssrn.3833523

Jeffrey A. Busse

Emory University - Department of Finance ( email )

Atlanta, GA 30322-2710
United States
404-727-0160 (Phone)
404-727-5238 (Fax)

Kiseo Chung

Texas Tech University - Area of Finance ( email )

Lubbock, TX 79409
United States

Badrinath Kottimukkalur (Contact Author)

George Washington University ( email )

2121 I Street NW
Washington, DC 20052
United States

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