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I find that over my sample period until the end of , the most active stock pickers have outperformed their benchmark indices even after fees and transaction costs. In contrast, closet indexers or funds focusing on factor bets have lost to their benchmarks after fees. The same long-term performance patterns held up over the financial crisis, and they also hold within market cap styles.
Closet indexing increases in volatile and bear markets and has become more popular after Cross-sectional dispersion in stock returns positively predicts average benchmark-adjusted performance by stock pickers. We find that these alphas primarily arise from the disproportionate weight the Fama-French factors place on small value stocks which have performed well, and from the CRSP value-weighted market index which is historically a downward-biased benchmark for U.
We explore alternative ways to construct these factors and propose alternative models constructed from common and easily tradable benchmark indices. The index-based models outperform the standard models in common applications such as performance evaluation of mutual fund managers. It describes the share of portfolio holdings that differ from the benchmark index. We determine the type of active management for a portfolio by measuring it in two dimensions using both Active Share and tracking error volatility.
We apply this approach to the universe of all-equity mutual funds to characterize how much and what type of active management they practice.
We test how active management is related to fund characteristics such as size, expenses, and turnover in the cross-section, and we examine the evolution of active management over time. Active management also predicts fund performance: funds with the highest Active Share significantly outperform their benchmark indexes both before and after expenses, and they exhibit strong performance persistence even after controlling for momentum.
Non-index funds with the lowest Active Share underperform. Keywords: Portfolio management, Active Share, tracking error, closet indexing October published version working paper Journal of Financial and Quantitative Analysis, , 44 5 lead article An earlier and more comprehensive version, including results on endogeneously arising institutions and optimal institutional structure pdf file Separate appendices: Empirical tests pdf file and a more elaborate model pdf file Representative agent models are inconsistent with existing empirical evidence for steep demand curves for individual stocks.
This paper resolves the puzzle by proposing that stock prices are instead set by two separate classes of investors. While the market portfolio is still priced by individual investors based on their collective risk aversion, those individual investors also delegate part of their wealth to active money managers who use that capital to price stocks in the cross-section.
In equilibrium the fee charged by active managers has to equal the before-fee alpha they earn; this endogenously determines the amount of active capital and the slopes of demand curves. Keywords: Demand curves for stocks, delegated portfolio management, equilibrium mispricing, index premium.
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Shakasida To purchase short term access, please sign in to your Oxford Academic account above. Oxford University Press is a department of pefajisto University of Oxford. Title Cited by Year How active is your fund manager? Email alerts New issue alert. Shock Propagation and Banking Antto.
Inefficiencies in the Pricing of Exchange-Traded Funds