Passive Investment Research Articles

How Investors Use Passive for Active

Index mutual funds and ETFs have seen significant asset inflows over the past decades. What is often overlooked about index fund investing, however, is that investors use these products to build active exposures in aggregate. To empirically explore this conclusion, we analyze the characteristics of the asset-weighted aggregate portfolio of US domiciled US equity index mutual funds and exchange-traded funds whose goal is to track an index other than a total US market index. Our results suggest that this portfolio of index funds is active in nature. This conclusion rests on (1) the non-trivial variability of excess returns relative to the total US equity market, (2) statistically significant style factor exposures, and (3) industry-level asset weights that are not market capitalization proportional to the total US equity market. In other words, index fund investing should not be considered equivalent to passive investing.

Are Investment Managers Worth Their Keep? A 7-year Evaluation of Active and Passive Investment Performance of a University Endowment

This study examined the financial performance of Schreiner University’s actively managed endowment and compared the performance to a hypothetical passive investment strategy. From 2014 to 2020, the actively managed endowment produced a cumulative return of 71.7%. In comparison, the passive, index-based portfolio produced a cumulative return of 72.9%. The actively managed portfolio outperformed the passively managed portfolio in four out of seven years but underperformed overall. The performance results of the assets classes were inconsistent throughout the seven-year period. Additionally, a passive strategy of 60% US equities and 40% US bonds would have resulted in a cumulative return of 98.9% over seven years.

The Emergence of the Actively Managed ETF

Since the first exchange-traded fund began trading in 1993, the ETF form has attracted enormous investment flows. However, this triumph of the ETF has been overwhelmingly limited the world of passive investment. Due to a mix of recent market innovation and regulatory change, this state of affairs is changing today. As I explain in this Article, there is much reason to believe that the actively managed ETF is now set to emerge as a significant feature of the investment landscape. And this emergence has important implications for, among others, the main parties that play key roles in protecting investors (namely, the Securities and Exchange Commission as well as investment intermediaries).

Introduction

Well-functioning securities markets are critical to the stability of the U.S. financial system, yet they are changing rapidly. Both securities markets and investors have new complexions, adding to the conventional picture of domestic public trading. For example, an increasing number of transactions today are private. Worldwide, private investment grew more than 250% between 2010 and 2019 before dipping with the COVID-19 pandemic, and in the United States, Regulation D offerings roughly doubled in the decade from 1997 to 2017. Simultaneously, cross-border asset holdings have risen: between 2012 and 2021, American holdings of foreign securities have increased by about 100%, while foreign holdings of American securities have increased by about 125%. New investment strategies have gained popularity, too. Capital increasingly flows through institutions—which, in the United States, in 2019 held assets equal to 291.3% of U.S. GDP, up from 249.3% of GDP in 2012—and into passive investment vehicles. Now, passive investment strategies tracking various indices of market or industry performance and traditional active management strategies each direct about 15 trillion in assets. Both retail and environmental, social, and governance investing, though heretofore less successful in generating investment, have made notable strides of late, as well.

Passive Investors and Audit Quality: Evidence from the U.S.

Passive Investors and Audit Quality: Evidence from the U.S.

Passive Investment, Active Isomorphism: The Rise of Index Funds in the U.S. Financial Industry

Passive Investment, Active Isomorphism: The Rise of Index Funds in the U.S. Financial Industry

Beyond Net Zero: How to Mobilize Passive Investing Towards Paris Alignment With a Focus on the United States

This paper provides a comprehensive and evolving framework for Paris-aligned passive investing, developed through expert consultations, using existing Paris Agreement-related frameworks, taxonomies, data sources, and principles. The framework is then used to analyze existing popular US sustainable funds and EU Paris-Aligned Benchmark funds to see how well they fulfill the criteria, revealing considerable deficiencies in portfolio construction across the board.

Linking the Robo-advisors Phenomenon and Behavioural Biases in Investment Management: An Interdisciplinary Literature Review and Research Agenda


 
 
 Technological advancements bring continuous changes into the investment industry. The paper aims to provide insights on future research agenda based on a review of the current stance of research on the links between the Robo-advisors phenomenon and behavioural biases of individual investors. A qualitative investigation method has been applied for literature review on Robo-advisors and their impact on behavioural biases.
 The key findings indicate that Robo-advisors can help users to make better informed and less biased decisions. However, Robo-advisors activate the investors’ automatic system processes. The resulting passive investment approach could lead to alienation of the investors from the stock market, decreasing their understanding of the investment process that could widen a gap between different clusters of investors.
 The paper makes several contributions to the literature. First, it provides arguments on why a dual process theoretical framework in the relationship between financial advisory and investment behavioural biases is applicable. Second, it studies the Robo-advisor phenomenon and proposes a comprehensive definition of Robo-advisors. Third, the literature review suggests drivers of the Robo-advisors effect on the changes of behavioural biases as a future research direction.
 
 

Are enhanced index funds enhanced?

AbstractOne of the major trends in the mutual fund industry is the rising importance of passive investing. One of the responses of the investment community to this challenge has been the creation of enhanced return index funds. In this paper, we examine the performance of enhanced index funds and find that they outperform index funds when we analyze both pre‐expense performance (management ability) and post‐expense performance (investor returns). However, when we use any of several criteria that have been proposed for picking the best fund from among those following some index, index funds outperform enhanced index funds.

The Spin Maneuver

The financialization of commodity markets has recently become a broadly discussed phenomenon, but its implications for commodity investors to a large extent remain unknown. This article focuses on whether the potential benefits of passive investment strategies in the commodity futures markets are expected to continue with increased financialization of the commodity futures markets. First, a regression analysis is conducted in order to examine the correlation between financialization and the disappearance of roll yields. Second, after finding such a correlation, we assume that this correlation is driven by increased financialization, which <i>causes</i> the decline in roll yields. Third, simulation-based methods are implemented to examine the revised efficient frontiers after accounting for the potential impact of financialization on roll yields. Our empirical research is based on returns on various asset classes and other related variables over the period 1990–2012. As noted, our computations indicate that market financialization may have resulted in a decline in roll returns. This decrease in roll yields, should it continue, is of a potential magnitude such that therationale for including commodity futures in traditional stock-and-bond portfolios would be seriously undermined. <b>TOPICS:</b>Commodities, futures and forward contracts, simulations, performance measurement

Analysis on Factors Affecting Performance of Indexing Investment

This article analyzes the current status of indexing investment performance in China and the characteristics of fund managers and fund management companies. It also theoretically analyzes the influence of these factors on indexing investment performance in terms of fund governance structure, characteristics of fund managers and fund companies, stock selection ability and timing ability. Next, it uses multiple regression analysis from three dimensions mentioned above to verify the influencing factors on investment performance. The results show that in terms of passive investment, fund tracking error is significantly negatively correlated with institutional holdings and fund managers’ stock selection ability, and significantly positively correlated with fund managers’ timing ability. Female fund managers’ tracking errors are smaller. Institutional investors play a positive role in promoting the performance of active investment. The fund manager’s stock selection ability can effectively reduce the fund’s sensitivity to target index fluctuations, and the fund manager’s timing ability can significantly improve the performance of fund allocation. Funds allocated by female fund managers will be less sensitive to target index fluctuations. Keywords: indexing investment, performance, fund management, fund managers DOI: 10.7176/RJFA/12-22-01 Publication date: November 30th 2021

Continuous innovation in factor credit strategies

There is an large body of academic literature that documents the existence of factor premiums that enable investors to construct portolios that generate better risk-adjusted returns than passive investing. To ensure that such factor-based investment strategies continue to deliver on their objectives, continuous innovation is required, for example by further enhancing factor definitions and investment processes and investigating alternative sources of data. In this article we show two examples of recent innovations in the field of factor investing for corporate bonds.In the first study, we document how factors can be successfully applied to hard-currency emerging market credits. Size, low-risk, value and momentum factor portfolios outperform the emerging market credit universe on a risk-adjusted basis, for example shown by higher Sharpe ratios. A multi-factor portfolio moreover benefits from diversification between the individual factors and obtains the highest information ratio. The factor portfolios benefit from bottom-up allocations to countries as well as from bond selection within these countries. Analysing the break-even transaction costs shows that these factors remain attractive after taking transaction costs into account. While generic factors offer a good starting point, more complete risk-assessments limit the exposure to unrewarded risk. In the second study, we extend previous research that showed that the text from annual and quarterly corporate reports filed with the Securities and Exchange Commission can be used to predict equity returns and volatility. We examine whether the text in these reports is informative for corporate bond returns and volatility as well. Particularly, we test if bonds of ‘non-changers’, companies with few changes in their reports over time, outperform bonds of ‘changers’. In a large sample of corporate bonds over a twenty year period we find that results for equities do carry over to corporate bonds: in both the investment grade and high yield sub-samples non-changers outperform changers by more than 50bps annually.

Investor activism strategies of private equity firms: evidence from continental Europe

PurposeThis paper aims to deal with the issue of shareholder activism of private equity investors in public companies. The study identifies characteristics of target firms and investors related to the likelihood of private equity activism. The research also examines whether shareholder activism strategy of private equity investors is associated with the better performance in future and value creation of target firms.Design/methodology/approachThe paper applies econometric modeling to hand-collected data on private equity investments in listed companies, in the form of private investment in public equity and open-market share purchases, from eight Continental Europe’s countries for the period 2005–2014.FindingsThe findings indicate that the probability of shareholder activism is higher if the target firm’s industry corresponds to the private equity investor’s industry specialization, if the private equity firm is older, if the target is larger and the average ownership share purchased by the investor is higher. Conversely, the probability of shareholder activism is lower where a private equity firm invests in the target for the first time. A target firm with an activist investor has poorer operational performance results one year following the investment compared to a target firm with a passive private equity investor.Research limitations/implicationsResults from the analysis of transactions in Continental Europe countries with French and German legal origin may be not generalizable to other markets with the different legal tradition and institutional environment.Originality/valueThis research provides new empirical evidence on private equity activism in listed companies of Continental Europe. By distinguishing between active and passive investments, testing rarely considered characteristics to provide valuable insights and analyzing the effect of activism on the target firm’s performance, the study contributes variously to the still-limited body of literature on private equity activism in public companies with a governance structure based on concentrated ownership. The findings emphasize the relationship between shareholder activism and both target and investor’s characteristics from perspective of mitigating agency problem and value creation in target firms. By simultaneously investigating investments in public companies from several European markets, the study complements empirical evidence mostly obtained from studies of a single national market.

Passive trading and firm performance: A quasi-natural experiment using the TSE-OSE merger in Japan

We examine the impact of passive trading on firm performance using, as a quasi-natural experiment the merger between the Osaka Stock Exchange (OSE) and the Tokyo Stock Exchange (TSE) and the attendant inclusion of firms listed on the first section of the Osaka Stock Exchange in the TOPIX, a well-known market index covered by many ETFs and mutual funds. We document a positive market reaction for the first tercile OSE-only listed firms and marginally significant positive abnormal returns for the first tercile OSE firms that were also dual listed on the TSE around the merger announcement date. In addition, we observe a significantly positive reaction for the first tercile OSE-only listed firms in the weeks preceding index inclusion. The percentage of financial institutions investing in the first tercile, OSE1-only firms also increased in the post-inclusion period. The incumbents of the TOPIX Index experienced negative abnormal returns on the merger announcement date. In the long run, firms added to TOPIX exhibit neither higher firm value nor better operating performance than their counterparts that were already in the index. Our results are consistent with the strand of literature that finds no long-term significant impact of passive investors on firm performance.

Value creation in shareholder activism

We measure value creation by activist investors via structural estimation of a model of the choice between passive investment and activism. Our estimates imply that average returns following activist intent announcements consist of 74.8% expected value creation, or treatment, 13.4% stock picking, and 11.8% sample selection effects. Higher treatment values predict improvements in firm performance and lower proxy contest probabilities, whereas abnormal announcements returns do not, suggesting that our estimate identifies more effective activism campaigns. The evidence demonstrates the importance of using the joint distribution of investment strategies and announcement returns to recover the expected returns and costs of activism.

Discussion of “Obfuscation in mutual funds”: The role of financial advisers

The authors find that disclosure complexity strongly negatively relates to S&P 500 index fund returns. Because those returns are largely determined by fund fees, their evidence suggests that fund managers obfuscate to drive mutual fund investors into poor investment choices. However, the use of a passive (indexed) investment strategy can overlap with another prominent feature of the mutual fund industry: financial advisers (i.e. “money doctors,” Gennaioli et al., 2015) who assist with investment planning and implementation. The overlap can generate perverse inferences of consumer choice – seeming indifference to substantially different fees for substantially similar investments. The evidence suggests that obfuscation plays an important supporting role in the symbiosis between mutual funds and financial advisers.

Active and Passive Investing: Understanding Samuelson’s Dictum

Abstract We model how investors allocate between asset managers, managers choose portfolios of multiple securities, fees are set, and security prices are determined. Investors are indifferent between higher-cost informed managers and lower-cost uninformed managers, interpreted as passive managers as their portfolio is linked to the " expected market portfolio." We make precise Samuelson's dictum by showing that active investors reduce micro-inefficiencies more than they do macro-inefficiencies. In fact, all inefficiency arises from systematic factors when the number of assets is large. Further, we show how the costs of active and passive investing affect macro- and micro-efficiency, fees, and assets managed by active and passive managers. Our findings help explain the rise of delegated asset management and the resultant changes in financial markets.

Cryptocurrencies as Pension Fund Components: Smart Move or Drinking the Kool-Aid?

This study investigates whether cryptocurrencies can be considered a viable addition to pension funds. Using the regulatory setting of Switzerland, it is assessed whether adding crypto-components to a standard pension fund portfolio has positive effects on the fund’s risk and return figures. The empirical data supports the notion that cryptocurrency components may well increase the yield of a pension fund portfolio, yet this enhancement of yield comes at slightly higher risk levels. This increase in risk can be mitigated by adding an actively managed crypto-component to the portfolio rather than a passive investment product. The paper contributes to the ongoing debate in the area of financial innovations on the purpose and solidity of cryptocurrencies as an asset class.

Are enhanced index funds enhanced?

One of the major trends in the mutual fund industry is the rising importance of passive investing. One of the responses of the investment community to this challenge has been the creation of enhanced return index funds. In this paper, we examine the performance of enhanced index funds and find that they outperform index funds when we analyze both pre-expense performance (management ability) and post-expense performance (investor returns). However, when we use any of several criteria that have been proposed for picking the best fund from among those following some index, index funds outperform enhanced index funds.

Cost, Performance, and Benchmark Bias of Public Pension Funds in the United States: An Unflattering Portrait

I estimate that statewide pension funds in the United States incur annual investment expenses averaging 1.3% of asset value. A sample of 24 of them underperformed passive investment during the past decade by an average of 1.4% a year. And yet, those same funds report that they outperformed benchmarks of their own devising by an average of +0.3% a year for the same period. This sharp disconnect raises questions about the usefulness of the funds’ performance reporting, as well as their heavy reliance on expensive active management.