Passive Investment Research Articles

Tracking Smart Beta indices during different market phases: A “smarter” option for passive investors?

Purpose This study aims to examine whether tracking Smart Beta (SB) indices during bullish, bearish and stagnant market phases is a better choice for passive investors compared to Cap-Weighted (CW) indices. As investors’ strategies differ with market movements, this study analyses how single-factor and multi-factor SB indices perform during different market phases, in relation to CW indices. It also attempts to determine which SB factors are more suitable for investors in these phases. Design/methodology/approach Using various return and risk indicators, this study analyses how SB indices perform vis-à-vis CW indices during bullish, bearish and stagnant phases. The authors also evaluate the upside and downside participation advantage of SB indices and assess their ability to capture upside returns and limit downside risk. The authors attempt to determine the cyclical or defensive nature of SB indices using Average Participation values. Findings This study found that SB indices outperform CW indices during the bearish and stagnant phases. Multi-factor SB indices have lower risk levels in all market phases, providing downside protection to risk-averse investors. Dividend, Low Volatility, Quality and multi-factor SB indices are defensive portfolios offering better payoffs during the down market phases, while Alpha, Beta, Equal Weight and Value SB indices provide higher payoffs during the up-market phases. Originality/value To the best of the authors’ knowledge, this is the first study that examines the performance of single-factor and multi-factor Indian SB indices in different market phases. It determines the suitability of various factors to passive investors during these phases and also identifies whether SB indices are cyclical or defensive.

Evaluating robo-advisors through behavioral finance: a critical review of technology potential, rationality, and investor expectations

The mini review assesses the value propositions of robo-advisors through the lens of behavioral finance. Despite their promise of data-driven, rational investment strategies, robo-advisors may not fully replicate the personalized service of human financial advisors or eliminate human biases in decision-making. A content analysis of 80 peer-reviewed articles and publications was conducted, focusing on the intersection of financial technology and behavioral finance. Literature was retrieved using The Chicago School University Library's OneSearch and the EBSCO host database, with key terms including “robo-advisor,” “investment behavior,” “risk tolerance,” “financial literacy,” and “affective trust.” The review identifies four key limitations of robo-advisors: (1) their inability to replicate the service-relationship of human advisors; (2) the presence of human bias in supposedly rational algorithms; (3) the inability to minimize market risk; and (4) their limited impact on improving users' financial literacy. Instead, robo-advisors temporarily compensate for a lack of financial knowledge through passive investment strategies. The findings suggest that integrating behavioral finance principles could enhance the predictive power of robo-advisors, though this would introduce additional complexities. The review calls for further research and regulatory measures to ensure that these technologies prioritize investor protection and financial literacy as they continue to evolve.

How Does Shareholding by Passive Institutional Investors Impact the Corporate Governance of European Firms?

ABSTRACTResearch Question/IssueThe passive investment (PI) trend, characterized by the increasing inflow of investment funds into PI strategies, has resulted in an increase in the share of corporate ownership held via investments in PI strategies. This paper investigates this trend's consequential impact on European companies' corporate governance (CG).Research Findings/InsightsWe find that higher ownership by passive institutional investors (PIIs) is associated with fewer female directors, reduced independence in audit and nomination committees, and higher executive pay, negatively impacting CG. Nevertheless, our findings show that PIIs can increase the probability that a company has a policy regarding the adequate experience of board members and equal treatment of shareholders.Theoretical/Academic ImplicationsWe hypothesize that the level of ownership could be the missing link connecting mixed theories about the impact of ownership by PIIs on the CG of companies they invest in. A curvilinear relationship between the two could allow conflicting theories to coexist in one framework. We find weak evidence for a curvilinear relationship, but this relationship may become more prevalent if PII ownership of European companies increases because of regulatory changes.Practitioner/Policy ImplicationsSome critics have proposed limiting PII voting rights, but our findings suggest that the effect of PII ownership may become less negative beyond a certain level of ownership and that PIIs may play a positive role in enhancing board experience and shareholder equity policies. Restricting PIIs may not necessarily be beneficial for the CG of companies they invest in.

An algorithmic approach to portfolio construction: A Turkish stock market case

The goal of building a diversified portfolio is to mitigate risks and manage risk-reward tradeoffs. Diversification is also crucial for ensuring the long-term success of a portfolio. Although passive investment has been on the rise in most developed markets, it has not gained wider acceptance in some emerging markets, such as Türkiye. This study proposes an approach to construct a diversified portfolio that serves as a passive investment tool in the context of the Turkish stock market. Despite the long history of equity markets in Türkiye, almost all available passive investment alternatives are prohibitively expensive, unlike those in developed markets. We design a simple methodology that addresses the essential components of building a successful portfolio while avoiding excessive fees. Additionally, we propose a dynamic balancing strategy that algorithmically adjusts the weight of each stock in the portfolio. We test this approach with historical data, demonstrating that it can achieve reasonable returns with minimal effort. Even when its performance does not beat the benchmark, the percentage deviation is still below the management fees charged for alternative investments.

The countdown to carbon neutrality: Implications for passive investors

In 2019 the European Union (EU) Climate Benchmarks Regulation established a set of standardized emission reduction criteria for financial benchmarks. This study examines the risk-adjusted performance of equity exchange-traded funds (ETFs) tracking EU Climate Transition Benchmarks (CTBs) and EU Paris-Aligned Benchmarks (PABs). Our findings reveal that, after the implementation of the regulation, equity CTB ETFs have exhibited no significant risk-adjusted performance difference compared to their non-sustainable twin ETFs. Conversely, equity PAB ETFs, which adhere to more stringent environmental standards, have underperformed their non-sustainable counterparts. Our results suggest that stringent emission reduction objectives have a negative effect on investors’ returns.

Risk-return adaptive receding Horizon Index Tracking Strategy

Index tracking is a well-established financial strategy for passive investing. Typical index tracking models are single period in nature, deriving an optimal tracking portfolio based on future price/return estimates, using most if not all index constituent assets. In this article, we propose a framework for index tracking that can accommodate multi-periods and asset selection. First, we propose a risk-return-based index tracking strategy within a multi-period adaptive receding horizon framework. The framework demonstrates strong tracking fidelity with the benchmark whilst accounting for future tracking states. We then adapt a Penalized Alternating Direction Method (PADM) to the multi-period framework to efficiently enforce a limit on tracking portfolio size (cardinality). The PADM produces high-quality solutions to the cardinality-constrained models and can be used effectively in both low and higher re-balancing frequency environments. Finally, we generalize our base multi-period formulation to an enhanced index tracking strategy, which can easily accommodate possible portfolio manager (PM) preferences. We present computational results that indicate that our cardinality-constrained and non-cardinality-constrained adaptive receding horizon framework for index tracking yields high tracking accuracy when compared to equivalent single-period or return-based models used in a rolling horizon framework.

Passive Investment and Share Repurchases

SYNOPSIS We investigate the association between passive investment and share repurchases, both of which are at historically high levels and the subject of increased scrutiny. We first document that firms with more passive ownership exhibit higher levels of repurchase activity. Next, and more importantly, we find that firms with passive ownership conduct more “suspect” repurchases that result in reported earnings that meet or beat analysts’ earnings forecasts, and this effect is more pronounced for firms with performance-based equity compensation incentive plans. We also find that repurchase activity more negatively affects firms’ future employment, capital expenditures, and performance when the firm has more passive owners. We conclude that passive investment is associated with an increase in the quantity and a reduction in the quality of firms’ repurchase activities. Our study provides evidence that passive institutional investment may allow opportunistic management behavior rather than serving the monitoring role traditionally associated with institutional ownership. Data availability: Data are available from the public sources cited in the text. JEL Classifications: M41; G32; G35.

Do passive investors influence corporate social responsibility? A risk‐management perspective

Do passive investors influence corporate social responsibility? A risk‐management perspective

The Active Versus Passive Investing Debate: Evidence From the 2018-2023 Market Cycle

The paper investigates the research question: Which investment management style, active or passive, produced better risk-adjusted performance from January 1, 2018, to December 31, 2023 (Prondzinski, 2010)? The comprehensive time period was further subdivided into two periods: January 2020 – May 2023, the Pandemic period, and March 2022 – December 2023, the interest rate hiking period without any interest rate cuts. The study tested twenty-seven hypotheses derived from this research question for the specified periods addressed. The study, consisting of 27 statistical tests, found that on a risk-adjusted basis, the Sharpe ratios of active indices (proxies for active management) significantly exceeded the passive indices (proxies for passive management) in nine of the periods tested) (Prondzinski, 2010).

The Persistence of Equity Mutual Fund Performance: Further Evidence from an Emerging Economy

This study evaluates the persistence of performance of actively managed, equity-based mutual funds in Nigeria using monthly net asset values (NAVs) of 30 funds obtained from the Securities and Exchange Commission over 10 years from 2012 to 2021. We employed a non-parametric technique based on the Contingency Table to test for performance persistence, using the Cross-Product Ratio (CPR) and the Rank Correlation statistics. Evidence shows that mutual funds do not exhibit performance persistence, and the performance of loser funds does not repeat, hence past performance does not predict future performance. Therefore, we recommend that retail investors (and their advisers) should not rely on historical performance to select mutual funds as an investment vehicle. This study provides valuable insight into the performance of actively managed funds in Nigeria and contributes to the ongoing debate about the efficiency of the financial markets and the role of active fund management. It suggests that investors might be better off with passive investment management strategies, given the lack of persistence in the performance of actively managed funds.

Selective and Market Timing Skills: An Empirical Evaluation of Equity Mutual Funds in an Emerging Market

This study evaluates the selective and market timing skills of mutual funds managers using monthly net asset values of all 30 actively managed equity-based funds that operated from January 2012 to December 2021 obtained from the Securities and Exchange Commission. Selectivity is the ability to search for and choose undervalued securities to exploit the sub-optimal market weights of securities, while market timing is the ability to forecast the direction of the market and adjust portfolio betas to generate alpha. Two regression models, namely the Treynor-Mazuy (1966) and Henriksson-Merton (1981) were deployed for the study. The findings indicate that mutual funds did not exhibit significant selective skills or market timing abilities. This outcome is consistent with the Efficient Market Hypothesis (EMH). Consequently, it becomes challenging for investors or fund managers to consistently outperform the market through stock selection or market timing. Based on the study's results, the recommendation for investors is to consider low-cost passive investment strategies, such as index funds or exchange-traded funds (ETFs), over actively managed funds.

Passive Institutions and Long-Run CEO Compensation: Evidence from Proxy Voting

A one-standard-deviation increase in passive ownership leads to a 25% increase in the compensation duration. I find proxy voting is the channel through which passive investors affect incentive horizons. Since the passage of the Dodd-Frank Act, passive funds tend to vote more against Say-on-Pay (SOP) proposals, and SOP proposals are less likely to pass with higher passive ownership. Moreover, passive ownership is associated with a greater number of shareholder-sponsored compensation proposals and an increased likelihood of these proposals passing. The overall findings indicate that passive institutions work to lengthen CEO compensation to align incentive horizons, and proxy voting is the mechanism through which they exert influence.

The rise of passive investing: a systematic literature review applying PRISMA framework

Purpose Passive investing has established itself as the dominant force in the world of professionally managed assets, surpassing the concept of index funds. Its meteoric rise is fueled by investors’ preference for its dual benefits of strong diversification and low cost. A comprehensive study of the economic model, addressed areas and market structure has not yet been conducted, despite the existence of numerous studies on more specific topics. To address this gap, this paper examines 943 articles on passive investing published between 1998 and 2022 in SCOPUS and Web of Science.Design/methodology/approach The study utilizes the most pertinent tools for conducting a systematic review by the PRISMA framework. This article is the result of SLR and extensive bibliometric analysis. Contextualized systematic literature review is used to screen and select bibliographic data, which is then subjected to a variety of bibliometric analyses. The study provides a bibliometric overview of works on passive investment research that are indexed in Scopus and Web of Science. Bibliometrix, VoS Viewer and Cite Space are the tools used to conduct content and network analysis, to ascertain the present state of research, as well as its focus and direction.Findings Our exhaustive analysis yields important findings. One, the previous decade has witnessed a substantial increase in the number of publications and citations; in particular, the inter-disciplinary and international scope of related research has expanded; Second, the top three clusters on “active versus passive funds,” “price discovery and market structures” and “exchange-traded funds (ETFs) as an alternative” account for more than fifty percent of the domain’s knowledge; Third, “Leveraged ETFs (LETFs)” and “environmental, social and governance (ESG)” are the two emerging themes in the passive investing research. Fourth, despite its many benefits, passive investing is not suitable for everyone. To get the most out of what passive investing has to offer, investors, intermediaries and regulators must all exercise sufficient caution. Our study makes a substantial contribution to the field by conducting a comprehensive bibliometric analysis of the existing literature, highlighting key findings and implications, as well as future research directions.Research limitations/implications While the study contributes significantly to the field of knowledge, it has several limitations that must be considered when interpreting its findings and implications. With our emphasis on academic journals, the study analyzed only peer-reviewed journal articles, excluding conference papers, reports and technical articles. While we are confident that our approach resulted in a comprehensive and representative database, our reliance on Elsevier Scopus and Web of Science may have resulted in us overlooking relevant work accessible only through other databases. Additionally, specific bibliometric properties may not be time-stable, and certain common distribution patterns of the passive investing literature may still be developing.Practical implications With this study, it has been possible to observe and chart the high growth trajectory of passive investing research globally, especially post-US subprime crisis. Despite the widespread adoption of passive investing as an investment strategy, it is not a one-size-fits-all proposition. Market conditions change constantly, and it frequently requires an informed eye to determine when and how much to shift away from active investments and toward passive ones. Currency ETFs enable investors to implement a carry trade strategy in their portfolios; however, as a word of caution, currency stability and liquidity can play a significant role in international ETFs. Similarly, LETFs may be better suited for dynamic strategies and offer less value to a long-term investor. Lastly, the importance of investor education cannot be underestimated in the name of the highly diversified portfolio when using passive alternatives, for which necessary efforts are required by regulators and investors alike.Social implications The inexorable trend to passive investing creates numerous issues for fund management, including fee and revenue pressure, which forces traditional managers to seek new revenue streams, such as illiquid and private assets, which also implies increased portfolio risk. Additionally, the increased transparency and efficiency associated with the ETF market indicates that managers must rethink the entire value chain, beginning with technology and the way investments interact. Passive investments have triggered changes in market structure that are still not fully understood or factored in. Active management and a range of valuation opinions on whether a price is “too low” or “too high” provide much-needed depth to a market as it attempts to strike a delicate balance between demand and supply forces, ensuring liquidity at all price points.Originality/value I hereby certify that I am the sole author of this paper and that no part of this manuscript has been published or submitted for publication.

Contrasting the Performance of Active and Passive Unit Trusts under Normal Market Conditions: Is the Experience of Emerging Markets Different?

The predominant tradition in the literature is to scrutinise the competitive performance of passive and active investment strategies with less regard to the prevailing market climate. The thesis of this paper is that volatile market conditions may necessitate investment strategy adjustments. Such readjustments may confound empirical comparison of passive and active investing if econometric models do not adapt accordingly. Currently, the literature cannot give a stylised fact of whether the historical claims of passive–active relationships relate to normal market conditions or not, which is a flaw. The present study reduces the flagged knowledge gap by answering the question whether passive investment outperforms active investing under normal market conditions. The study applies the parametric and non-parametric risk-adjusted models of the Jensen alpha and Sharpe index. The empirical analysis is based on the weekly returns of 16 unit trusts listed on South Africa’s Johannesburg Stock Exchange for ten years (between 2009 and 2019). Consistent with the hypothesis of inefficient capital markets in developing economies, the study finds that active investing significantly outperforms passive investment strategy under normal market conditions. The results should benefit investors and policymakers in the era of increasing competitiveness, digitalisation, and globalisation.

Comparison of Markowitz Model and Index Model in Different Constraints

This paper reviews the application of Markowitz model and index model in portfolio optimization and focuses on comparing the performance under different constraints. The study covers the core concepts and theoretical framework of modern portfolio theory and the development of the two models. The Markowitz model employs quantitative analysis to consider the expected return and risk of assets and aims to maximize investor utility. The index model, on the other hand, achieves investment objectives by replicating the performance of a specific index. Comparative analysis shows that the Markowitz model is suitable for active management, while the index model is more suitable for passive investment. With the advancement of computing technology, the application of Markowitz model will be more accurate and extensive. Meanwhile, as the concept of passive investment becomes popular, the index model will continue to attract more investors. This study is of great significance to investors in choosing investment strategies, and will help academia and the industry to further optimize investment models.

Green Assets and Global Portfolio Tail Risk? A Stress-Testing exercise under multiple asset classes under distinct market phases

Despite a burgeoning literature in the sphere of cryptocurrencies and green assets, yet, as of date, the literature fares poorly in terms of a holistic assessment of all asset classes, let alone stress testing such global portfolio risk under various market conditions. Our paper fulfills such a gap in the literature. Findings reveal that, irrespective of bearish or bullish market phases, green assets should be incorporated to mute down portfolio tail risk. Robustness tests performed either via different distribution type or CVaR analysis do not materially alter the main findings of our paper. The confluence of two forces substantially boosts tail risk, namely, passive investment strategy coupled with a crypto-augmented base model. Overall, our paper advocates the inclusion of green assets not as a choice but as an obligation to portfolio managers in view of curtailing both VaR and CVaR risk levels, all geared towards hitting two birds with one stone-simultaneously buttressing a greener world while effectively mitigating global portfolio tail risk.

Comparison of Active And Passive Investment Strategies on The Indonesian Stock Exchange 2013 -2024 With The Magic Formula Method

Comparison of Active And Passive Investment Strategies on The Indonesian Stock Exchange 2013 -2024 With The Magic Formula Method

Effect of Investment Strategies on Portfolio Performance of Individual Investors in the Nairobi Securities Exchange

This study sought to determine the effect of investment strategies on the portfolio performance of individual investors in the Nairobi securities exchange. A descriptive cross-sectional survey approach was adopted. The population for this study were individual investors in the Nairobi Securities Exchange. A sample of 384 respondents was used. Both primary and secondary data were collected in this study using a questionnaire and data collection tool. Data were analyzed using descriptive and inferential statistics. The strongest correlation was observed between the active investment strategy and portfolio performance, followed by growth, passive and value strategies. From regression analysis, there was a strong positive correlation between investment strategies and performance. The relationship between investment strategies and performance was also found to be significant. It was revealed that growth and active investment strategies were statistically significant predictors of portfolio performance, with positive relationships. Active investment strategy had the largest beta coefficient, indicating that it is the most important of the four strategies in affecting portfolio performance, followed by value investment strategy and growth investment strategy, while passive investment strategy had the least influence on portfolio performance. The study concludes that investment strategies have a strong, positive and significant effect on the portfolio performance of individual investors in the Nairobi Securities Exchange. The study recommends that Nairobi Securities Exchange ought to encourage individual investors to educate themselves about various investment strategies and their potential impact on portfolio performance. It is also recommended that Nairobi Securities Exchange emphasize the importance of diversification to reduce risk.

RESEARCH PAPER FOR USING MARKOWITZ MODEL AND INDEX MODEL UNDER REALISTIC ADDITIONAL CONSTRAINTS

The Markowitz and index models are widely used in portfolio optimization to achieve optimal asset allocation and maximize returns while controlling risk. However, in practical investment scenarios, additional constraints often need to be considered to ensure the feasibility and effectiveness of the portfolio strategy. This research focuses on incorporating realistic additional constraints into the Markowitz and index models for portfolio optimization. The study utilizes historical financial data and statistical techniques to estimate expected returns, variances, and covariance matrices. The Markowitz model is modified to incorporate the additional constraints, allowing for more realistic and accurate portfolio optimization outcomes. The index model is also adapted to consider the impact of these constraints on the construction and performance of passive investment portfolios.

Strategic borrowing from passive investors

Abstract We find that short sellers manage risks by strategically borrowing shares in stocks with significant ownership by passive investors. This practice increases securities lending demand for stocks with substantial passive ownership, resulting in improved price efficiency, higher lending fees, and increased short interest in these stocks. Consistent with the risk mitigation motive, these stocks show reduced risks of unexpected fee hikes and loan recall, longer loan durations, and attract more informed short sellers. These effects are particularly pronounced in hard-to-borrow stocks where short-sale constraints are binding. Our study suggests that passive investing helps alleviate short-sale constraints by reducing the risks associated with stock borrowing.