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Mimicking Portfolios of Five ETFs Beat Most Active Mutual Funds?

Posted in Strategic Allocation

Can investors beat a typical active U.S. equity mutual fund via a small portfolio of periodically re-weighted equity exchange-traded funds (ETF)? In their February 2019 paper entitled "Are Passive Funds Really Superior Investments: An Investor Perspective", flagged by a subscriber, Edwin Elton, Martin Gruber and Andre de Souza:

  1. Determine via cluster analysis a small set of ETFs that captures most of the variation in 69 broad U.S. equity indexes.
  2. Explore use of this set to mimic past performances of many active U.S. equity mutual funds via 24-month linear regressions with ETF coefficients scaled to sum to one.
  3. Compare next-year (close of first trading day of the year after coefficient calculation to close of first trading day next year) returns of mimicking ETF portfolios and active mutual fund counterparts.

Their target set of 883 active U.S. equity mutual funds are those with at least: three years of data as of January 2003; $15 million in assets; and, 90% of assets allocated broadly to stocks. Using monthly returns for 69 U.S. equity indexes, the small set of passive equity ETFs that capture variation in these indexes and 883 active U.S. equity mutual funds during January 2003 through December 2018, they find that:

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