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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  1. […] And this chart (right) from a recent Economist article (see posting) combines Vanguard’s estimates and ETFs onto one chart.  […]

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