Active mutual funds and their passive ETF investments

Abstract

Investing in exchange-traded funds (ETFs) rather than investing directly in the underlying securities surely prompts questions for mutual funds. Why? Examination suggests the answer is to reduce overall portfolio volatility. Actively managed open-end equity funds (OEFs) that invest in ETFs tend to take short positions in securities and to short ETFs more than other securities. Investigation of the overlap in portfolio composition between OEFs and the ETFs they hold as well as their investing positions in hedging and nonhedging ETFs separately points to the main motivation for such ETF investment—hedging.