Passive Management: ETF “dark matter”
May 1st, 2007 | Filed under: CAPM / Alpha Theory
Last week’s Economist piece on the ballooning ETF industry contained a chart that gave us pause (right). It illustrates not only the growth of ETFs (vs. traditional open-ended index funds), but also the overall growth of indexing (currently over 16% of all US equity mutual funds). While 16% may sound high, that’ nothing compared to the hidden ETFs buried within all US equity mutual funds. It’s as if there is a huge amount of “dark matter” hidden between active stock picks.
We were reminded of this study by Martijn Cremers & Antti Petajisto of the Yale School of Management (originally written last summer and covered in these pages but recently updated). Cremers and Petajisto propose a new measure of active management to complement the traditional market correlation measure (a.k.a. “tracking error”). Instead of looking at a fund’s return stream to infer the size of its active and passive components, the new metric actually measures the deviation of each holding from index weights. Cremers & Petajisto suggest this measure be used as a complement to, not a replacement for, tracking error.
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[…] And this chart (right) from a recent Economist article (see posting) combines Vanguard’s estimates and ETFs onto one chart. […]