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Passive versus Active Fund Performance: Do Index Funds Have Skill?

Published online by Cambridge University Press:  14 February 2018

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Abstract

We apply methods designed to measure mutual fund skill to a cross section of funds that is unlikely to exhibit managerial portfolio selection skill: index funds. Surprisingly, these tests imply index fund skill exists, is persistent, and is in similar proportion as in active funds. We use the distribution of passive fund performance to gauge the incremental ability of active managers. Outperformance by top active funds is lower when benchmarked to the index fund distribution and disappears when we account for residual risk. Stochastic dominance tests suggest no risk-averse investor should choose a random active fund over a random index fund.

Type
Research Article
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2018 

Footnotes

1

We thank Kerry Back, Jonathan Berk, Hendrik Bessembinder (the editor), Martijn Cremers, David De Angelis, Stephen Dimmock, Hitesh Doshi, Nick Hirschey, Nishad Kapadia, Andy Koch, Sebastien Michenaud, Dermot Murphy, Barbara Ostdiek, Sugata Ray, Jonathan Reuter, Jules van Binsbergen, James Weston, Eric Zitzewitz (the referee), and seminar/conference participants at Rice University, the 2014 Lone Star Finance Conference, the 2014 Conference on Financial Economics and Accounting, and the 2016 Financial Intermediation Research Society Conference for helpful discussions and comments.

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