ETF Positions within Actively Managed Mutual Fund Portfolios

Abstract

We provide the first in-depth examination of exchange-traded funds (ETFs) within actively managed mutual fund (AMMF) portfolios to better understand why AMMFs make substantial investments in passive ETFs. We examine if holding ETF positions explains AMMF performance, as well as the impact an ETF position has on indirect measures of performance, including market timing, flow management, and cash holdings. We find that over one-third of AMMFs take an ETF position between 2004 and 2015. Our results indicate that AMMFs allocating large portions of their portfolio to ETFs perform worse, after controlling for style and characteristic differences, by between 0.40% and 1.63% annually using various performance measures. These AMMFs also exhibit worse market timing and hold more cash. In contrast, AMMFs that hold ETFs in small amounts have similar characteristics to non-user AMMFs. Therefore, the act of holding an ETF does not signal inferior ability, however, taking large ETF positions does.