[Financial Analysts Journal] Are Passive Funds Really Superior Investments? An Investor Perspective,

Edwin J. Elton, Martin J. Gruber & Andre de Souza (2019) Are Passive Funds Really Superior Investments? An Investor Perspective, Financial Analysts Journal, 75:3, 7-19, DOI: 10.1080/0015198X.2019.1618097

To link to this article: https://doi.org/10.1080/0015198X.2019.1618097 

In the last ve years, passive funds have increased from 16.4% of the assets under management to 26%.

An investor seeking to use passive portfolios to beat an active fund and attempting to use the Fama–French (market, small cap, value) or Carhart (these three plus momentum) methodology does not have an easily implementable strategy. 

(1) the authors searched for a parsimonious set of indexes that correctly price other indexes and (2) the authors show that exchange-traded funds (tradable assets)—rather than indexes—can be used to construct a set of portfolios that outperform active mutual funds. ETFs can be bought and shorted.

The authors found that a combination of five ETFs captures most of the variation in all available ETFs. Five ETFs consist of CRSP Market, Russell 1000 Growth, Russell 1000 Value, Russell 2000 Growth, and Russell Midcap Value 

Investors can outperform active funds by buying the lowest-cost ETF that matches each fund’s benchmark, but they can do significantly better by using the five-ETF model the authors developed in this study.