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The Active-Passive Debate

Wednesday, November 1, 2017
9 a.m. – 2:15 p.m.

The Smith Suite
Ronald Reagan Building
1300 Pennsylvania Avenue NW
Washington, DC 20004

According to the Investment Company Institute’s 2017 Fact Book, active funds accounted for more than 80% of global mutual fund assets under management in 2016, at nearly $11 trillion. But the data fail to recognize the change in the mutual fund market since 1993, when active funds accounted for more than 98% of a $1.5 trillion global market. The Center for Financial Policy and CFA Institute will consider the ramifications of these changes in investor preferences.

The event examines:

  • What do these changes mean for the investment strategies of funds of index funds, active-managers and pension fund managers?
  • How will these changes affect financial market regulations, from disclosure requirements to market structure and systemic risk issues?

Fee $25.

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Papers discussed at the event:

The Evolution and Success of Index Strategies in ETFs
CBOE Vest
Joanne Hill

This article explains why and how ETFs are a significant innovation propelling further growth in indexing with respect to both tactical and strategic investment strategies for institutional and retail investors.

Index Investing Supports Vibrant Capital Markets
Blackrock
Barbara Novick, Samara Cohen

Index investing has profoundly changed the way investors seek returns, manage risk, and build portfolios by providing low cost access to diversified investments for all investors. Change is often disruptive to established norms, and we’ve seen a cadence of commentary citing concern about the growth of index investing. Some of the media headlines have been arresting, but are not supported by the data, and lack a common language around key asset management concepts. While the benefits of index investing are widely recognized, recent focus has been on the impact of index investing on capital markets. We see two broad themes emerging, which explore: I.) The impact of index investing on the efficient functioning of capital markets; and II.) The impact of index investing on stock ownership and competition in underlying markets. We address the role that index investing plays in equity markets. In particular, we respond to commentary that asks whether index funds and ETFs have the potential to distort investment flows and hinder price discovery. In March 2017, we addressed academic theories on the role of index investing in relation to competition in the ViewPoint: Index Investing and Common Ownership Theories.

In Pursuit of Alpha: Evaluating Active and Passive Strategies
Vanguard
James Rowley, Garret Habron, Matthew Tufano

We find that the average gross alpha for U.S. equity funds and ETFs is roughly zero on an equal-weighted and asset-weighted basis but that average net alpha is negative on both an equal-weighted and asset-weighted basis. Conducting multivariate regression, we find that expense ratios have no relationship to gross alpha, that higher portfolio turnover is associated with lower gross alpha, and that prior year gross alpha is not an indicator of current year gross alpha. From the standpoint of investment strategy and portfolio construction, however, a critical finding is that these effects apply to all funds—both actively managed and indexed.

Mutual Fund Performance: An Empirical Decomposition into Stock-Picking Talent, Style, Transactions Costs, and Expenses
Robert H. Smith School of Business, University of Maryland
Russ Wermers

We use a new database to perform a comprehensive analysis of the mutual fund industry. We find that funds hold stocks that outperform the market by 1.3 percent per year, but their net returns underperform by one percent. Of the 2.3 percent difference between these results, 0.7 percent is due to the underperformance of nonstock holdings, whereas 1.6 percent is due to expenses and transactions costs. Thus, funds pick stocks well enough to cover their costs. Also, high-turnover funds beat the Vanguard Index 500 fund on a net return basis. Our evidence supports the value of active mutual fund management.

Center for Financial PolicyCFA Institute