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Report Presents a Critical View of ETF Performance in Actively Managed Mutual Funds

An academic report that describes itself as the first in-depth analysis to focus on passive ETF holdings in actively managed funds proposes that there is strong evidence that the use of small ETF positions does not put actively managed fund portfolios at a disadvantage but that the use of large passive ETF positions can be a “red flag” for investors and can signal significant underperformance. The paper examined the association between holding ETF positions and actively managed fund performance, as well as indirect measures of performance. The authors found that actively managed mutual funds allocating large portions of their portfolio to ETFs perform worse, by between 0.41% and 1.63%, annually using various performance measures. In contrast, similar funds that hold ETFs in small amounts showed similar characteristics to funds that did not use ETFs. The report’s authors concluded that the act of holding an ETF does not signal inferior ability for a fund’s performance, however, taking large ETF positions does. According to the authors, the study results held across various measures of performance, across various actively managed fund styles, and across measures of market timing and cash management.