Are Passive Funds Really Superior Investments? An Investor Perspective

Abstract

A number of papers have demonstrated that over historical periods, a specified set of factors has outperformed actively managed funds. In almost all cases, however, the factors used or the procedures followed are not replicable by tradable passive investments. In addition, tradable passive investments have expense ratios that almost always cause them to underperform indexes. The purposes of this article are to identify a small set of exchange-traded funds that captures most of the variation in the population of potential indexes and to determine whether a combination of exchange-traded funds from this small set can be identified that outperforms active mutual funds in future periods.