Active ETFs and their performance vis--vis passive ETFs, Mutual

Funds and Hedge Funds*

Panagiotis Schizas
Lecturer of Finance
Department of Economics
University of Peloponnese
22 100 Greece
Email: panagiotis.schizas@gmail.com
6/2/2011
Abstract
This work presents empirical results on the first active exchange traded funds (ETFs)
based on risk, return and incentives. Using models for both the returns and the volatility
of the underlying assets, I compare the performance of the suggested models with
alternative investment solutions such as passive ETFs, mutual funds and hedge funds.
The results show that active ETFs are not as active as they are considered by market
participants. The link between active and passive ETFs is strong, however the difference
in performance and risk weighs on the side of the passive ETFs. The results indicate also
that, in many cases, the active structure is surpassing mutual funds in terms of returns.
Finally, there is a unidirectional relation between active funds and hedge funds, since the
former is influenced by the latter.

Keywords: Active ETFs; Passive ETFs; Mutual Funds; Hedge Funds; VAR.

The author appreciates helpful and insightful comments and suggestions by Gary Gastineau and
professor Dimitrios Thomakos.

Electronic copy available at: http://ssrn.com/abstract=1872125

Introduction
The decision in March 2008 by the Securities and Exchange Commission to
approve the listing of Active Exchange Traded Funds (active ETFs) in the US market
opened up a new form of asset management. Exchange-traded funds1 are considered a
passive investment solution that combines the dynamics of index-tracking unit trusts
with the merits and tradability of listed investment companies. Its structure surpasses the
major demerits of the aforementioned two vehicles given lower operating expenses,
trading liquidity, and more efficient tax structures than the conventional index-tracking
mutual funds. The launch of the active ETFs faces the challenge to maintain those
distinctive properties and let investors gain access to actively managed portfolios.
Nevertheless, the unique merit of full transparency of a passive ETF becomes the main
drawback of the new investment structure due to the obligation of mandatory disclosure
of the constituent holdings in addition to any re-balancing in real time.2
Full transparency means the daily disclosure of the entire portfolio and presents
the problem of front running, since the disclosure in real time of the portfolio
allocation could lead investors to replicate the allocation more promptly than the fund.
As a result, fund managers in the real world are reluctant to disclose their allocation in
real time. On the other hand, incomplete knowledge of the constituents of the
underlying portfolio violates the process of proper trading and could lead the market
maker to be misinformed and, consequently, fail to provide a fair price to the
investors3. Gastineau (2001) proposed the creation of a hedged portfolio as a proxy with
identical risk profile, so the market makers, specialists, investors and arbitrageurs can be
aware of risk exposure. The success of the new active structure depends on the ability to
overcome the aforementioned obstruction.
There is a lack of related empirical evidence on the relative performance of active
ETFs. Rompotis (2009), (2010) examined the performance and the bid-ask spread of the
first 4 active ETFs. On the contrary, there is extended literature based on passive ETFs,
1

Passive ETFs are considered a highly liquid passive worldwide investment strategy. There are
3,649 Exchange Traded Funds (ETFs) and Exchange Traded Products (ETPs) with 7,610 listings, assets of
US$1,542.7 bn from 174 providers on 52 exchanges around the world (Blackrock ETF Landscape (March
2011)).
2
As the legislation calls for the investors and market-makers information, stock exchanges are obliged to
publish the indicative NAV every 5 seconds. In turn, dissemination of NAV requires the full knowledge of
the underlying portfolios. Dissemination of NAV was the major obstacle, due to which 18 years passed
after the inception of the first passive ETF before an actively managed ETF was born in the US.
3
There is a compulsory narrow spread between NAV and the floating price that specialists and market
makers should follow. The prompt disclosure benefits mainly professional investors since they are able to
replicate the identical allocation, without paying ETFs expenses.

Electronic copy available at: http://ssrn.com/abstract=1872125

such as the ability to mimic the index (Gastineau (2004), Frino et al (2004), Elton et al
(2002)), the correlation between NAV and trading prices ((Cherry (2004), Delcoure and
Zhong (2007), Tse and Martinez (2007)) and the existence of tax efficiency characteristics
(Poterba et al (2004)). Pennathur (2002), Hughen et al (2007), Harper et al (2006)
investigated the different properties of ETFs and closed end funds, Tse et al (2006) and
Hausbrouck (2003) compared the spot and futures ETFs and Alexander et al (2007) and
Cabrera et al (2009) examined the predictability of the ETFs. Gleasona et al. (2004)
examined ETFs in periods of market instability and high volatility. Hendershott et al
(2005) examined ETFs and alternative trading venues, Boehmer et al (2003) and Hedge
et al (2004) investigated liquidity effects and Ascioglu et al (2006) compared ETFs and
common stocks.
This paper has three main objectives in its examination of active ETFs. The first is
to explore the structure of an active ETF and the obstacles that arise by the inception of
the new investment tool. The second objective is to examine and evaluate the
performance and the risk profile of the investment. Finally, to present its similarities and
the differences compared to alternative investment options such as passive ETFs,
conventional mutual funds and hedge funds.
Results show that current active funds have not as active as the market participants
expected, as the tracking error from the passive funds is low. The differences in
allocation between the active and the passive structure points out that active ETFs fail to
time the market as the latter appear to be less profitable and more volatile. The relative
comparison between active ETFs and hedge funds exhibits a unidirectional impact
deriving from the hedge funds. The analysis of active ETFs found they outperform
conventional mutual funds in the sense of mean returns.
The structure of this paper is as follows: Section 2 presents the ETFs
characteristics, section 3 gives a description of the database and the variables, and section
4 describes the methodology. Section 5 presents the main empirical results of the active
ETFs. This section also demonstrates a comparative analysis between the active ETFs,
the passive ETFs, the mutual funds and the hedge funds. Section 6 provides conclusions.

From Passive to Active ETFs: the similarities, the differences

and the obstacles

Active ETFs do not passively follow prescribed benchmark as passive ETFs do

and instead employ actual portfolio managers who either use rules-based strategies or
make portfolio calls based on a stated qualitative strategy. The legislation-imposed rule of
full transparency obliges that any amendment to the ETF should be disclosed promptly,
so that all participants are aware of the risk of the underlying portfolio.4 However, full
transparency in an active ETF creates several negative consequences, while, the major is
the front running problem. A solution that in practise clearly separates active and
passive ETFs could be named as exemptive relief and blind trust. Exemptive relief
means periodic portfolio disclosures identical to those in place for mutual funds, so every
three months with a specific lag. Blind trust working on behalf of an authorized
participant (AP) keeps the holdings of the portfolio hide. So, the blind trust becomes the
vehicle of the creation and redemption mechanism. The availability of real-time pricing
information will allow market participants to hedge trading exposures in shares
effectively and permit the efficient trading of shares in the market place without the need
for daily disclosure of the funds portfolio holdings. Moreover, the blind trust could
hedge the funds for the exact cash value of the funds value. So, creation units will be
created exclusively by the deposit of cash and will be redeemed by distributing securities
of the funds portfolio to a blind trust that will liquidate securities in accordance with
instructions from the authorized participant redeeming shares. Furthermore, the
liquidation of ETF shares, will come up as cash to the AP, which never knowing what
made up the ETF shares that the blind trust redeems. Consequently, the adviser and the
fund subadviser are totally independent entities to an authorized participant to appoint in
transactions under the act. The proposed structured do not lose tax efficiency
characteristics of the passive ETFs since the in-kind process of creations and
redemptions takes place in the blind trust which is able to avoid imbedded capital gains.
Moreover, this structure eliminates the cash drag problem.
A different aspect is the predefined allocation of the passive ETFs, since investors
are no longer concerned with the dilemma which exchange traded fund, under the same
strategy, to prefer. On the contrary, investors on active ETFs base their decisions on the
managers ability to generate profits. Therefore, the resignation of the fund manager

By legislation the stock exchanges are obliged to publish the INAV - indicative net asset value- every 5
seconds in order for the market maker to be informed about the ratio between the ETF and the underlying
index. For the index linked ETFs, the legislation restricts an ETF to fluctuate more than 3% (including
taxes) from the underlying index.

often has negative impact on the final performance of the fund as a result of a different
allocation.

Dataset Characteristics
There are limitations in this work since there are only five active ETFs in the
market with an adequate number of observations. The first four active ETFs launched
on April 2008 while the last one was added after its inception on November 24, 2008.
The data span extends from April 16, 2008 to March 4, 2010. More precisely, the funds
are:

Active Low duration ETF (ticker: PLK), tracks Barclays Capital 1-3 Year US treasury
index. The fund was launched on April 14, 2008 and has 7.62 million worth of assets
under management. The respective passive ETF that applied for the relative
comparison is Ishares Barclays 1-3 years (ticker: SHY).5

Active Mega Cap ETF (ticker: PMA), tracks S&P500 index. The fund was launched
on April 14, 2008 and has 3.48 million worth of assets under management. The
respective passive ETF is SPDR S&P500 (ticker: SPY).

Active AlphaQ ETF (ticker: PQY), tracks Nasdaq 100 index. The fund was launched
on April 14, 2008 and has 19.32 million worth of assets under management. The
respective passive ETF is Powershares QQQ (ticker: QQQQ)

Active Alpha Multi cap ETF (ticker: PQZ), tracks S&P 500 index. The fund was
launched on April 14, 2008 and has 4.46 million worth of assets under management.
The respective passive ETF is SPDR S&P500 (ticker: SPY).

Active US real estate ETF (ticker: PSR), tracks FTSE Nareit equity index. The fund
was launched on 21 November 2008 and has 11.53 billion worth of assets under
management. The respective passive ETF is Ishares FTSE Nareit real estate 50
(ticker: FTY). All the aforementioned active ETFs are provided by Powershares.
Clearly, the first active ETFs have not yet been matched by asset flows. Most

likely, the lack of interest is associated, with a lack of a well established track record,
which makes many advisors not to steer investors to them. As such, it's less likely that
active ETF assets will grow rapidly until customary track records are established.
Moreover, the first active ETFs could easily argue that follow traditional investment
strategies. The trading properties of the first active ETFS underline the imposed

Passive ETFs are the biggest funds based on market capitalization with respect to identical investment
strategy.

constraint of limited number of trades (not to exceed three trades per week). The
requirements of prompt disclosure that legislation imposes can be merely alleviated by
two specific solutions. The first solution refers to the option to hidden portfolio
reshuffling for the event day. In practise, the execution of the reshuffling could occur
every Friday. The manager has the time to mark and reveal his investment strategy before
the next business, on Monday. Unlike equity index ETFs, front running declines on
ETFs with fixed income strategies, which are not so easy to conquer to arbitrage
activities and may trade more frequently. Further to this point the next generation of
active ETFs are focused on the fixed-income, money markets, and global macro.
In order to compare the active ETFs with the mutual funds, I collected the mutual
funds data in the following way: For each active ETF, I found the corresponding
Morningstar category6, I downloaded the fifteen biggest mutual funds of each peer group
and then calculated the daily mean return of each group. According to the Morningstar
categorisation for each active Fund PSR stands for Real Estate, PMA for large blend,
PLK for short government bonds, PQY for large growth and PQZ for mid-cap growth.
The horizon of the data span is identical to the active ETFs.
The data sample for the hedge funds is a result of search in the CISDM/hedge
funds database. In this work, I only used the hedge funds that include in their strategy
the key words government bonds, equity with exposure to the US market and real
estate, thus aligning with the categories of the active ETFs. The second step was to
calculate the mean return of each peer group. As it is known, hedge funds are organized
in monthly data and there is a delay in the available observations, so, while the data span
starts in April 2008, it ends in April 2009.

Methodology
This section presents and discusses the methodology and the approach that was
implemented in this paper. The first equation relates the return of the active ETF rta to
the age variable (AGE) which represents the number of the months since the inception
of each ETF7, the trading activity (TA) which stands for a dummy variable that takes the
value of one if there is a trading activity (it is otherwise zero) and the turnover variable
(TO) which stands for the daily log turnover of each fund.

In the prospectus of each ETF the Morningstar category to which it belongs is stated.
The same variable has been applied to examine hedge funds behaviour as they mature by Ackermann et
al. (1999).
7

rta a 0 a1 AGE t a 2TAt a3TOt t

(1)

The next test tries to examine the twenty-day moving correlation ycor ,t between
the active and passive ETFs, with the inclusion of a lagged dependent variable, a dummy
variable as well as the cross-term.
ycor ,t a0 0 It a1 ycor ,t 1 1 ycor ,t 1It t

(2)

It I (rt d ,b c)

(3)

where It I (rt d ,b c) is a dummy variable which stands for an indicator for lagged
negative return of the benchmark - c being a fixed threshold, which in the estimations is
considered as zero. The estimations test for non-linearity and structural breaks. The
intuition behind this test is very crucial since the presence of any asymmetric response
points out that the correlation of the active structure strengthens more than the
correlation of the traditional passive ETFs.
In the second section, three different empirical equations are examined, where the
dependent variable is either the return of the active ETF rta or the return of the passive
ETF rtp . Equation (4) examines the impact of the Fama-French factors on the return of
the active ETFs, the passive ETFs and the mutual funds. The independent variables are
the market factor (M), which stands for the value weighted market excess return, the
(HML) variable, which stands for the book-to-market portfolio of high minus low
stocks, the (SMB), which stands for the size of the portfolio based on small equities
minus big equities and the (MOM), which stands for the portfolio of year long winners
minus year long losers.
rta a 0 a1 M t a 2 HMLt a3 SMBt 4 MOM t t

(4)

The last part of this section examines through an OLS regression if standard risk
factors affect the returns and the risk of the active and passive ETFs. The risk factors
are:

DVG: The DRussell Value-Growth factor is expressed by the daily log difference
between the Russell 1000 value and the Russell 1000 growth index

HFI: the hedge fund index stands for the daily log difference of the generic hedge
fund index

DSL: The DRussell Large-Small factor is expressed by the daily log difference
between the Russell 3000 and the Russell 2000 index
7

VIX: the volatility momentum factor is expressed by the daily log difference of the
VIX index

VOL: the volume variable is a dummy variable which takes the value of 1 if the
trading volume is greater than the trading volume of the previous day, otherwise
zero.

rta a0 a1 DVGt a2 HFI t a3 DSLt a4VIX t a5VOLt t

(5)

In the third section, I consider the following unrestricted vector autoregressive

model for the return of the active and passive ETFs against the return of their common
benchmark. The order of both models is selected by the AIC criterion. So,

rta
yt
rtp

(6)

xt rtb

(7)

where they are formed into a system as follows:

L yt xt ut
(8)

a
a
uta
where , and similarly for and ut
p
p
utp

(9)

Then, to check for any alpha asymmetries between active and passive ETFs I apply a
Wald test to check if the means of the two assets are identical both in the short run
means and in the long run means.

H o(1) : aa a p

(10)

H o( 2) : a p

(11)

a
where,
p

(12)

and (1)

(13)

where (12) and (13) check for any dissimilarities into the long run means. Also, the
methodology, as presented by equations (6) to (13), is applied between the means of the
active ETFs and the respective mean of each group of the mutual Funds.
8

The last part of the third section, examines asymmetries between the return of the
active ETFs and the hedge funds, but in the context of panel data due to the lack of
sufficient observations of the hedge funds. The dependent variable is either the return of
the active ETF

rta

or the return of the hedge funds

rt ,hf

and the estimations

experimented with the inclusion of the lagged values of the active ETFs and the hedge
funds and the contemporaneous values either of the active ETFs or the hedge funds.
rta a0 a1 Rt 1,a a2 Rt ,hf a3 Rt 1,hf t

(14)

rt ,hf a0 a1 Rt 1,hf a2 R,ta a3 Rt 1,a t

(15)

In equations (14) and (15) I applied a panel OLS cross section regression with
fixed effects and GLS weights and then I checked for any alpha asymmetries through a
Wald test as in (10).

Summary characteristics of the Active ETFs

Table 1, represents the basic features and descriptive statistics of the active ETFs.
[Insert Table 1]
Table 2 investigates, through an OLS regression (1), the relation between the
return and the risk of each ETF against a set of variables in order to check for
abnormalities related with the infant period of the funds8. The estimations indicate that
PMA, PQY and PQZ are positively linked to the age variable. This behaviour can be
explained as the investors have alternative solutions and increase their interest only as the
funds mature. The return of PMA was found to be negatively related with the turnover
variable.9
[Insert table 2]
Table 3 represents the OLS estimations of 5-day moving correlation of equations
(2) and (3). The results show that the current correlation is significantly related to the
lagged correlation across the ETFs.
[Insert Table 3]
8

I conduct the same OLS estimations using the daily volatility of the funds as independent variable, but
the variables do not have any influence on the volatility.
9
The low AUMs and the wide bid-ask spreads influence negatively the final performance of the ETFs and
consequently avert inventors to trade in. Moreover, professional investors are reluctant to invest since they
only implement their strategy for small amounts.

Table 4 shows the basic descriptive statistics of the active ETFs segmented by
different time horizons. This segmentation helps to compare the outcome during
different periods and investigates the behaviour of the funds as they are growing up. The
mean and the median values of the active ETFs are in majority worse compared with the
respective values of the passive funds. The risk of the active ETFs is found to be less
volatile than the risk in the passive ETFs, however the diversification benefit is not large
enough to compensate investors, as can be extracted from the worse Sharpe ratio.
Among the equity active and passive ETFs, the active funds are found to be negative
skewed with excess kurtosis while the passive ETFs are positive skewed, exposing less
excess kurtosis. PMA is the least volatile fund among the active ETFs. The passive
structure outperforms the active structure, contrary to expectations. Focusing on the
bond sector, PLK is the laggard in all the basic indicators and becomes more noticeable
in the relative comparison of the Sharpe ratio.
Panel B examines the tracking error of the active versus the passive ETFs10. The
results show that active and passive structures do not demonstrate any significant
diversification which is contrary to expectations. The most diversified active fund
appears to be the PSR which diverges 2.37 percent against the respective passive fund.
[Insert Table 4]

Active ETF structure and relative performance

This section performs a series of estimations to compare the performance of the
active ETFs versus the passive ETFs and the mutual funds. Table 5 provides the results
of equation (4) between the active and the passive ETFs, the mutual funds and the Fama
and French risk factors. Daily active return appears to be statistically significant with the
market factor, however, overall, less related than the return of the passive ETFs. PLK
and PSR exhibits the exceptions. Comparing the three equity funds -PMA, PQY and
PQZ- only PMA is negatively influenced by the size factor and the momentum trend of
the market. The results of the pair PSR-FTY show a strong positive relationship with the
size of the market. Mutual funds found to be uncorrelated both with the Fama and

10

The tracking error has been calculated as in Frino and Gallagher (2001) by estimating the average of
absolute differences between the returns of active ETFs and the returns of the corresponding passive
funds. This type of tracking error takes into account the absolute value of return differences which means
that either a positive or a negative deviation points out a performance deviation.

10

French factors. The only exception comes out from the HML factor in PSR-FTY pair,
where there is a positive link to ETFs and negative link to mutual funds.
[Insert Table 5]
Figure 1, shows the 5-day moving correlation between the PQZ and QQQQ and
the movement of the Nasdaq 100 index. The results indicate two crucial values, 0.5 and
0.0, as can be easily extracted from the results where the correlation between the active
and passive funds collapses. The figure outlines that as the index moves to the outliers,
the correlation diminishes. Table 6 represents the pairwise correlation for three different
periods in order to check for any clustering as I extend the estimation period. The results
point out that the bond sectors pair exhibits the biggest independence, while in contrast
there is the pair PQZ-QQQQ. On average, the equity ETFs exhibit strong correlation
which ranges between 0.58 and 0.83.
[Insert Table 6 & Figure 1]
Table 7 provides daily evidence of the style and market capitalization analysis of
both the active and passive structure. Estimations report the run of an OLS regression of
equation (5). Panel A provides evidence of the daily log returns against only the factors
that were found to be significant, while estimations did not include the bond sectors
ETF (PLK). The vertical analysis shows that PQY and PQZ are the only active funds
that indicate the existence of alpha, however, the daily excess return is half than the
respective return of the passive funds. PMA exhibits zero excess return, unlike the
respective passive ETF. PMA and PSR align with the behaviour of the passive funds,
which are found to be positively related to the style factor. The pairs PMA-SPY, PQYQQQQ and PQZ-SPY are strongly related to the hedge fund index and the volume
factor. However, PQY and PQZ are affected in a different direction by the daily volume.
The pair PQZ-SPY is affected negatively by the size factor while controversial results
arise between PMA and PQY, contrary to the passive funds. The fit of the regression is
greater in the passive structure than in the active structure, which confirms the
hypothesis that the active structure is less affected by the traditional factors.
Panel B tries to capture the existence of any patterns of the daily volatility between
the active and passive structure. The estimations show that pair PMA-SPY is negatively
related with the hedge fund index and the pair PSR-FTY is negatively related with the

11

Drussell large-small variable. Comparing Panel A and Panel B, the funds are strongly
affected by the daily trading volume.
[Insert Table 7]

Active versus passive

Table 8 shows the results of an unrestricted VAR estimation of equation (6), with
endogenous variables the returns of the active and the passive ETFs, and as exogenous
variable the daily return of the respective benchmark11. I found that the benchmarks
magnitude is longer in the active funds than in the passive funds. I will now discuss each
pair briefly. The pair PQY-QQQQ exhibits mean reversion for the active fund but not
for the passive. There is also feedback between the active and passive funds, as indicated
by their lagged values; however, the feedback is positive for the active ETFs and negative
for the passive ones. The benchmark is found to be insignificant. The pair PQZ-SPY
exhibits mean reversion only for the active ETF. There is strong positive feedback from
SPY to the PQZ; however, the feedback lies on the positive direction with the feedback
of its own lagged value. There is also high, almost one-to-one, influence of the
benchmark on both active and passive ETFs. The pair PSR-FTY has mean reversion for
both the active and passive fund. There is no link between the active and passive ETFs,
but both are affected by the benchmark. As expected, this effect is greater in passive
ETFs than in active ETFs. The pair PMA-SPY exhibits mean reversion for both types of
funds. There is a strong positive feedback from SPY to the PMA, although the passive
fund is found to be independent from the active. In addition, there is a strong influence
from the benchmark on both active and passive funds; however, the influence is almost
double the one expected in the passive funds. The pair PLK-SHY is found to be
unrelated, although it does exhibit mean reversion on the active ETF. Both funds are
strongly linked to the benchmark, even though the passive fund is found to be more
correlated.
[Insert Table 8]
In table 9, I compare the short and long run mean of the active and the passive
funds as indicated in (8) and (9) through a Wald test. The results indicate that in both

11

According to the AIC information criterion, the efficient lag intervals are found to be one.

12

tests, excess returns are identically zero, with p-values that are far above the acceptance
levels.
[Insert Table 9]

Active ETFs vs. Mutual Funds

Recent rule developments present a challenge as to whether active ETFs could
substitute for more conventional mutual funds or comprise a complimentary solution.
One of the open questions is if actively managed ETFs will become an extra ETF share
class on the traditional open-end structure or a separate, innovative fund type. The
questions arise since the legislation of active ETFs is based on the existing regime of the
mutual funds.12 Gastineau (2003) argued that the addition of an ETF share class to a
conventional open-end fund has a positive effect on the existing shareholders benefits
and a controversial effect on new shareholders. Moreover, fund portfolio scales trades
represent an offsetting positive factor, since the manager keeps the portfolio allocation
stable and limits the trades to inflows and outflows, keeping costs as low as possible.
Edelen et al (2007) assessed that the trading costs of the mutual funds are the highest,
proportionally, and the proportion depends on the capitalization scale of the fund. Zhao
(2002) argued that conventional mutual fund managers face the dilemma whether to
launch single or multi-class fund portfolios or to add one or more classes to the existing
fund. New classes in existing portfolios are primarily the results of the expansion of
traditional front-end loading and occur if the record track of the respective portfolio is
successful. Adverse front load funds have no reason to introduce a new share class13. A
further obstacle for a conventional fund to add up an ETF share class in the existing
fund is that conventional mutual funds require a holding period to mature and cannot be
a rational solution for short term investors or traders. It is not clear if the multiple share
class approach will be a hazard for existing investors, with respect to tax treatment,
expenses and performance. In a traditional index fund the addition of extra share classes
is not a hazard for the current investors.

12

The replacements among others are attributed to the disclosure of the performance NAV- as opposed
to the benchmark and the disclosure of portfolio allocation. Conventional open-end funds are restricted to
a quarterly disclosure within the next two months, which make up a 6-calendar-month horizon. Additional
changes are based on the literature, the marketing material and the statutory limits.
13
Gastineau (2001) argued that an inherent constrain arises by the nature of ETFs, as the index based
funds, such as S&P500 or Nasdaq 100, are useless when launched for 4 different shares classes, so the
analysis is referring to more complex strategies.

13

Table 10, examines the ability of the active funds to outperform the conventional
mutual funds in terms of mean returns. The results of the unrestricted VAR indicate that
the pair PQY-Mutual funds exhibits mean reversion, however, the reversion is weaker in
the mutual funds. PQY also appears to be independent from the mutual funds. The
results of the pair PQZ-Mutual funds also exhibit mean reversion, even though the
reversion is weaker in the mutual funds. There is a negative interrelation from the mutual
funds to the active fund. The pair PSR-Mutual funds exploits mean reversion as well,
which is stronger in the mutual funds; however, there is significant negative feedback
from the active fund to the mutual funds. The results of the pair PMA-Mutual funds
demonstrate that the funds are totally independent, while, on the contrary, the mutual
funds are showing mean reversion and a positive relation feedback from the PMA.
Although the pair PLK-Mutual funds exhibits mean reversion, there is no other relation
between the pair.
[Insert Table 10]
In table 11, I compare the short and long run mean of the active and the passive
funds as indicated in (8) and (9) through a Wald test. The results indicate no difference in
excess return between the active ETFs and the mutual funds, as p-values range above the
acceptable levels.
[Insert Table 11]

Active ETFs vs. Hedge Funds

There are many challenging prospects that the hedge fund industry and
quantitative funds would face in an active ETF structure. The rule of daily disclosure and
the aim for more control and transparency on the part of the regulators, especially after
the subprime crisis, raises a crucial question that needs to be answered in the near future:
Are active ETFs the efficient and rational path for the quantitative hedge funds to be
regulated vehicles? Their nature, due to frequent rebalancing, has implicitly developed a
rational mechanism to monitor daily allocation performance while the daily disclosures
do not give rise to any additional costs. The second aspect is that of manager appraisal.
Managers in the hedge fund industry are already evaluated in a very strict and intensive
time horizon, since their performance is what constitutes the reputation of the fund. For
specific types of quantitative funds, recommended allocation comes out from the
optimizer, where there is no need for extended managers comprehension. So, any type
14

of disclosure increases transparency and aids offshore funds in increasing their solvency
and their credibility to investors14.
Table 12 represents the results of equations (14) and (15) between the returns of
the active funds and the returns of the hedge funds. The findings confirm positive excess
only for the hedge funds. Active ETFs exhibit a unidirectional link with the hedge funds
and their lagged values. The response that comes out from the hedge funds versus to the
active ETFs is almost two times higher than the response that comes out from their
lagged values. The hedge funds exhibit a significant positive relation with the active
ETFs. Between the two investment products the fit of the regression is greater in the
hedge funds.
Panel B performs a relative comparison between the short and long means of the
active ETFs and the hedge funds. The results indicate no difference in excess return
between the active ETFs and the hedge funds.
[Insert Table 12]

Concluding Remarks
Active Exchange Traded Funds were under investigation in this paper. The
revolutionary decision of the SEC to permit trading of active ETFs ushered in a new era
in the asset management industry. However, law-mandated full transparency remains a
major obstacle.
Overall, the study proposes that although the infant period of the active funds is
not so successful, there is room for much improvement in the structure of the active
funds. Clearly, up to now, the first active ETFs have not yet been matched by asset
flows, while the first active ETFs can easy categorized as traditional equity index
strategies with limited added value for the investors. Of course, the notion of a broader
range of investment strategies could be more appealing to the investors. The next
launching of active ETFs includes strategies in short term fixed-income, money markets
and global macro. The results show that active ETFs are not as active as they appear to
the market participants. The link between active and passive ETFs is strong, but the
difference in performance and risk weighs on the side of the passive ETFs. Furthermore,
comparative evaluation with the mutual funds exhibits a superior performance and,
finally, there is a unidirectional relation between the active funds and the hedge funds,
since the former is influenced by the latter. Evidently, the results are subject to the low
14

There are exchange-traded funds (ETFs), known as quantitative based ETFs, which are supercharged by rules-based
and quantitative algorithms. The underlying index is based on a predefined algorithm.

15

activity and interest of the investors, since an increase in the popularity could improve
the performance of the active ETFs significantly.
The coming years will be enlightening as a number of industry sources say that the
many mutual fund companies that have made tentative steps to begin offering exchange
traded funds might leap first into the ETF business if the sec approves the exemptive
relief. According to industry sources large financial-services firms have filed for approval
to create ETFs. Clearly, the approval is a lengthy procedure. However, their empirical
evidence of an established customary track record of at least three years and the
launching of active ETFs from well-established investment managers will prove the
potential that can be achieved by the active ETFs.

16

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17

Frino, A., Gallagher, D., Neubert, A., Oetomo, T. Index Design and Implications for
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18

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and Mary, 2002.

19

Tables and Figures

Table 1
The table presents the seven features of the first 5 active ETFs and the mean, median and the standard
deviation of the first four features. The sample period is extended by the inception of each ETF, such as April
16, 2008 for the first 4 ETFs and since November 24, 2008 for the PSR. The last observation has been taken
on March 4, 2010.
PLK

PMA

PQY

PQZ

PSR

Mean

Median

Std.
Dev.

0,29

0,75

0,75

0,75

0,80

0,67

0,75

0,21

0,29

0,75

0,75

0,75

0,80

0,67

0,75

0,21

Size ($ millions)

7,62

3,48

19,32

4,46

11,53

9,28

7,62

6,43

Daily Activity ($)

98.477

46.612

93.737

68.317

101.035

81.636

93.737

23.508

23

23

23

23

17

EquityLarge
Cap
YES

EquityLarge
Cap
YES

EquityMulti
Cap
YES

Real
Estate

YES

Annual Management Fee

(%)
Expense Ratio (%)

Age (months)
Style
Manager

Bonds
NO

20

Table 2
The table presents OLS estimations of the first 5 active ETFs against three
basic variables. Panel A presents the regression of the return of the active
ETF. The sample period is extended by the inception of each ETF, such as
April 16, 2008 for the first 4 ETFs and since November 24, 2008 for the PSR.
The last observation has been taken on March 4, 2010. The age variable stands
for the number of months counted by the inception of each ETF and the
trading activity stands for a dummy variable taking the value of one if there is a
daily trading of the respectively ETF. The corresponding p-values are reported
for each separate variable and statistics are corrected for autocorrelation and
heteroscedasticity using the Newey-West estimator with 5 lags.
Intercept
AGE
Trading activity
Turnover

Observations

PLK

PMA

PQY

PQZ

PSR

0,000

-0,002

-0,002

-0,004

0,001

0,805
0,000
0,805
0,001
0,965

0,081
0,001
0,082
0,022
0,823

0,041
0,001
0,045
-0,011
0,907

0,050
0,001
0,053
-0,012
0,914

0,615
-0,001
0,619
0,343
0,418

0,000

0,000

0,000

0,000

0,000

0,942

0,000

0,219

0,920

0,766

0,000

0,008

0,005

0,004

0,002

474

474

474

474

319

21

Table 3
The table presents OLS estimations of 20 days moving correlation of
the active ETFs. The sample period is extended by the inception of
each ETF, such as May 13, 2008 for the first 4 ETFs, since December
24 for the PSR. The last observation has been taken on March 4, 2010.
Dummy variable stands for an indicator for lagged negative return of
benchmark and the cross term is the product of the dummy variable
and the lagged correlation. The corresponding p-values are reported
for each separate variable.
Return

PLK

PMA

PQY

PQZ

PSR

Intercept

0,006

0,021

0,028

0,020

0,010

Dummy Variable

0,365
0,001
0,895

0,088
0,006
0,729

0,015
-0,019
0,300

0,103
0,016
0,364

0,566
0,003
0,878

Lagged
Correlation

0,953

0,965

0,966

0,978

0,988

0,000

0,000

0,000

0,000

0,000

-0,017

-0,004

0,010

-0,033

-0,008

0,627

0,874

0,681

0,177

0,721

0,894

0,924

0,933

0,932

0,972

455

455

455

455

299

Cross Term

Observations

22

Table 4
Panel A represents the descriptive statistics in percentage for the first active ETFs. The sample periods have been
split up to six, twelve, and eighteen months, and at last I represent the estimations for the entire sample period in
order to check any abnormalities as the funds are growing up. Panel B represents the tracking error between the
active ETF and the respective passive ETF. The sample period is extended by the inception of each ETF, so since
April 16, 2008 for the first 4 ETFs, and November 24, 2008 for the PSR and ends on March 4, 2010. The n/a
notation indicates for the concrete period the respective ETF have not been launched.

Panel A
Mean

Median

Maximum

Minimum

Std. Dev.

Sharpe
Ratio

Stewness

Kurtosis

ACTIVE

PASSIVE

ACTIVE

PASSIVE

ACTIVE

PASSIVE

ACTIVE

PASSIVE

ACTIVE

PASSIVE

Sample
Period In
Months

PLK

SHY

PMA

SPY

PQY

QQQQ

PQZ

SPY

PSR

FTY

0,002

0,009

-0,311

-0,264

-0,248

-0,242

-0,367

-0,264

n/a

n/a

12

0,000

0,011

-0,126

-0,166

-0,156

-0,108

-0,237

-0,166

0,204

0,261

18

-0,002

0,009

-0,033

-0,047

-0,038

-0,004

-0,098

-0,047

0,225

0,238

All

0,001

0,009

-0,017

-0,029

-0,009

0,011

-0,069

-0,029

0,203

0,189

0,000

0,025

0,000

0,043

0,000

-0,188

-0,162

0,043

n/a

n/a

12

0,000

0,025

0,000

0,040

0,000

-0,142

0,000

0,040

0,000

0,585

18

0,000

0,024

0,000

0,064

0,000

0,064

0,076

0,064

0,000

0,374

All

0,000

0,013

0,000

0,108

0,000

0,103

0,074

0,108

0,000

0,319

2,823

0,709

7,085

13,560

12,726

11,452

13,032

13,560

n/a

n/a

12

2,922

0,709

9,473

13,560

12,726

11,452

13,032

13,560

15,932

22,602

18

2,922

0,709

9,473

13,560

12,726

11,452

13,032

13,560

15,932

22,602

All

2,922

0,709

9,473

13,560

12,726

11,452

13,032

13,560

15,932

22,602

-2,598

-0,560

-9,626

-10,364

-10,286

-9,396

-12,267

-10,364

n/a

n/a

12

-3,001

-0,560

-9,626

-10,364

-10,995

-9,396

-13,210

-10,364

-18,874

-19,089

18

-3,001

-0,656

-9,626

-10,364

-10,995

-9,396

-13,210

-10,364

-18,874

-19,089

All

-3,001

-0,656

-9,626

-10,364

-10,995

-9,396

-13,210

-10,364

-18,874

-19,089

0,641

0,193

1,943

2,427

2,593

2,407

2,803

2,427

n/a

n/a

12

0,731

0,169

2,412

2,819

2,661

2,666

3,411

2,819

4,569

6,708

18

0,665

0,153

2,089

2,418

2,326

2,288

2,946

2,418

3,993

5,080

All

0,622

0,142

1,918

2,210

2,141

2,104

2,686

2,210

3,436

4,351

0,003

0,048

-0,160

-0,109

-0,096

-0,101

-0,131

-0,109

n/a

n/a

12

0,000

0,067

-0,052

-0,059

-0,059

-0,040

-0,069

-0,059

0,045

0,039

18

-0,003

0,059

-0,016

-0,019

-0,017

-0,002

-0,033

-0,019

0,056

0,047

All
6
12

0,002
0,253
0,005

0,062
-0,018
-0,115

-0,009
-1,037
-0,244

-0,013
0,360
0,239

-0,004
0,133
0,104

0,005
-0,007
0,191

-0,026
-0,337
-0,517

-0,013
0,360
0,239

0,059
n/a
0,073

0,043
n/a
0,049

18

-0,096

-0,311

-0,342

0,124

-0,029

0,084

-0,677

0,124

-0,038

0,001

All

-0,094

-0,313

-0,379

0,100

-0,075

0,051

-0,753

0,100

-0,011

0,024

9,981

4,772

10,236

12,936

9,163

8,524

10,012

12,936

n/a

n/a

12

8,081

5,020

6,750

6,633

8,413

5,406

6,223

6,633

7,602

3,864

18

8,413

6,089

8,159

8,172

9,687

6,676

7,652

8,172

7,103

5,505

All

8,978

6,611

9,253

9,393

10,877

7,521

8,925

9,393

9,134

7,220

Panel B: Tracking
Error (%) Active vs.
Passive ETF

0,38

1,19

1,01

23

1,13

2,37

24

Table 6
The table presents the pairwise mean and median correlation between the active and passive ETFs.
The estimations have been considered for three different horizons, 5-days, 20-days and 60-days. The
sample period is extended by the inception of each ETF, such as April 16, 2008 for the first 4 active
ETFs and since November 24 for the PSR. The last observation has been taken on March 4, 2010.
PLK-SHY
5days

20days

PMA-SPY
60days

5days

0,115
0,129
0,121
0,149
PSR - FTY

0,579
0,739

20days
0,617
0,651
PQZ-SPY

PQY-QQQQ
60days

5days

20days

60days

0,619
0,656

0,690
0,825

0,708
0,762

0,729
0,739

mean
median

0,082
0,040

mean

5days
0,591

20days
0,629

60days
0,633

5days
0,637

20days
0,693

60days
0,716

median

0,786

0,777

0,641

0,778

0,751

0,733

25

Table 7
The table represents the empirical estimations of the active and passive ETFs. The
definition of the active ETFs and the data span is analysed in table (1). In Panel A and B, I
run an OLS regression against the daily return and the daily risk of each ETF respectively.
The risk stands for the range-based estimators. The table represents only the factors that
found to be significant. All table enters multiplied by one hundred. The corresponding pvalues are reported for each separate variable and statistics are corrected for autocorrelation
and heteroscedasticity using Newey-West estimator with 5 lags.
ACTIVE

PASSIVE

ACTIVE

PASSIVE

ACTIVE

PASSIVE

ACTIVE

PASSIVE

Panel A: Return

PMA

SPY

PQY

QQQQ

PQZ

SPY

PSR

FTY

Intercept

-0,001

-0,001

0,004

-0,001

0,002

-0,001

0,002

0,001

0,270

0,040

0,000

0,081

0,040

0,040

0,112

0,360

0,347

0,579

0,579

1,627

2,682

0,075

0,000

0,000

0,000

0,000

1,649

1,525

1,933

1,279

3,055

1,525

0,000

0,000

0,000

0,001

0,000

0,000

-0,271

-0,509

-0,436

-0,271

-1,102

-1,781

0,014

0,000

0,017

0,014

0,000

0,000

Drussell Value
- Growth
HEDGE
FUND INDEX
Drussell Large
- Small
Volatility
Momentum
Volume
R2

-0,082

-0,192

-0,131

-0,188

-0,160

-0,192

-0,176

0,000
0,003

0,000
0,003

0,000
-0,006

0,000
0,004

0,000
-0,004

0,000
0,003

0,000

0,062

0,004

0,000

0,001

0,021

0,004

0,726

0,412

0,633

0,508

0,305

Observations
Panel B:
Volatility
Intercept

474

474

0,726

0,215

474

0,572
319

PMA

SPY

PQY

QQQQ

PQZ

SPY

PSR

FTY

0,000
0,002

0,000
0,000

0,000
0,002

0,000
0,000

0,000
0,004

0,000
0,000

0,000
0,000

0,000
0,000

-0,011

-0,012

0,038

0,044

Drussell Value
- Growth

0,015
0,074

HEDGE
FUND INDEX

-0,014

-0,027

-0,031

-0,027

0,023

0,002

0,000

0,002

Drussell Large
- Small
Volatility
Momentum

0,001
0,091

Volume
R2

0,000
0,074

0,000
0,072

0,000
0,003

0,000
0,024

0,000
0,071

0,000
0,072

0,000
0,003

0,018

0,086

0,018

0,153

0,038

0,086

0,058

26

0,022

Observations

474

474

474

319

Table 8
The table represents the results of an unrestricted VAR specification between the daily mean of the
active ETF versus the daily mean of the passive ETF. The respective index has been applied as
exogenous variable. The definition of the active ETFs and the data span is analysed in table (1). The
t-statistic is represented in brackets.

Active ETF

Passive ETF

Benchmark

PQY(-1)
QQQQ(1)

NASDAQ

R-squared

Active
ETF

Passive
ETF

Active
ETF

Passive
ETF

Active
ETF

Passive
ETF

PQY

QQQQ

PQZ

SPY

PSR

FTY

-0,008

-0,008

-0,001

0,000

0,001

-0,001

[-1,53]

[-1,37]

[-1,00]

[-1,52]

[ 0,62]

[-1,13]

-0,299

0,022

-0,113

-0,004

[-7,14]

[ 2,44]

[-2,03]

[-0,14]

0,433

0,006

0,060

0,052

[ 8,46]

[ 0,59]

[ 1,29]

[ 2,19]

0,976

0,992

0,374

0,886

Benchmark

R-squared
Observations

PMA(-1)
SPY(-1)
Russell
200

PSR(-1)

-0,116

[-7,72]

[-1,75]

0,396

-0,027

[ 6,09]

[-0,40]

0,000

0,000

[ 1,52]

[ 1,41]

[ 29,70]

[ 142,12]

[ 9,20]

[ 43,00]

0,116

0,023

0,664

0,978

0,233

0,866

SPY(-1)

S&P500

474

Passive ETF

PQZ(1)

-0,493

Observations

Active ETF

474

Passive
ETF

Active
ETF

Passive
ETF

PMA

SPY

PLK

SHY

0,000

0,000

0,000

0,000

[-0,09]

[-1,49]

[-0,18]

[-0,02]

-0,299

-0,001

-0,389

0,006

[-7,36]

[-0,056]

[-9,13]

[ 1,20]

0,442

0,033

0,136

-0,124

[ 12,42]

[ 3,80]

[ 0,73]

[-5,51]

0,540

1,018

0,482

0,883

[ 17,89]

[ 139,49]

[ 2,55]

[ 38,63]

0,472

0,977

0,156

0,765

PLK(-1)

SHY(-1)

Barclays
1-3 years

474

474

27

FTSE
NAREIT

318

Active
ETF

FTY(-1)

Table 9
The table represents the results of Wald test between the daily mean of the active ETF versus
the daily mean of the passive ETF. The definition of the active ETFs and the data span is
analysed in table (1). The p-values are reported in nominal form.
Active
ETF

Passive
ETF

Active
ETF

Passive
ETF

Active
ETF

Passive
ETF

Active
ETF

Passive
ETF

Active
ETF

Passive
ETF

PQY

QQQQ

PQZ

SPY

PSR

FTY

PMA

SPY

PLK

SHY

Hypothesis Ho: Intercepts are equal

X2

0,006

X2

0,442

X2

1,133

X2

0,068

X2

0,030

p-value

0,9361

p-value

0,506

p-value

0,287

p-value

0,794

p-value

0,863

Hypothesis Ho: Long term means are equal

X2

0,084

X2

0,312

X2

1,235

X2

0,139

X2

0,029

p-value

0,772

p-value

0,576

p-value

0,267

p-value

0,710

p-value

0,864

28

Table 10
The table represents the results of an unrestricted VAR specification between the daily mean of the active
ETF versus the daily mean of the mutual funds. The definition of the active ETFs and the data span is
analysed in table (1). The t-statistic is represented in brackets.
Active
ETF

Mutual
Funds

Active
ETF

PQY
C
Active ETF
Mutual
Funds

PQY(-1)
Mutual
Funds (-1)

R-squared

0,000

[-0,11]

[-0,28]

-0,205

0,005

[-4,54]

[ 0,11]

-0,012

-0,118

C
PQZ(-1)
Mutual
Funds (-1)

R-squared
Observations

0,000

[-0,66]

[-0,44]

-0,110

-0,061

[-2,42]

[-1,73]

-0,126

Mutual
Funds (-1)

-0,068

C
PSR(-1)
Mutual
Funds (-1)

0,002

0,000

[ 1,14]

[ 0,08]

-0,143

0,003

[-2,56]

[ 0,04]

-0,065

-0,273

[-2,58]

[-2,13]

[-1,48]

[-1,63]

[-5,02]

0,042

0,014

0,021

0,011

0,027

0,074

474

Mutual
Funds

Active
ETF

PMA

Mutual
Funds

PSR

-0,001

474

PMA(-1)

Mutual
Funds

[-0,25]

Active
ETF

Active ETF

Active
ETF

PQZ

0,000

Observations

Mutual
Funds

318

Mutual
Funds

PLK

0,000

0,000

[-0,20]

[-0,23]

-0,045

0,134

[-0,97]

[ 2,90]

0,000

-0,135

[ 0,01]
0,002

0,000

0,000

[ 0,08]

[ 1,78]

-0,379

0,015

[-8,89]

[ 1,22]

-0,013

0,132

[-2,97]

[-0,087]

[ 2,90]

0,038

0,144

0,020

PLK(-1)
Mutual
Funds (-1)

474

474

29

Table 11
The table represents the results of Wald test between the daily mean of the active ETF versus
the daily mean of the mutual funds. The definition of the active ETFs and the data span is
analysed in table (1). The p-values are reported in nominal form.
Active
ETF

Mutual
Funds

PQY

Active
ETF

Mutual
Funds

PQZ

Active
ETF

Mutual
Funds

PSR

Active
ETF

Mutual
Funds

PMA

Active
ETF

Mutual
Funds

PLK

Hypothesis Ho: Intercepts are equal

X2

0,013

X2

0,064

X2

0,376

X2

0,000

X2

0,183

p-value

0,909

p-value

0,801

p-value

0,540

p-value

0,982

p-value

0,669

Hypothesis Ho: Long term means are equal

X2

0,016

X2

0,057

X2

0,440

X2

0,000

X2

0,469

p-value

0,901

p-value

0,812

p-value

0,507

p-value

0,992

p-value

0,493

30

Table 12
The table represents the results of a cross sectional estimation between the
return of the active ETFs versus the mean return of the group of Hedge
Funds. The definition of the active ETFs and the data span is analysed in
table (1). Panel B, represents the results of Wald test between the means of
the active ETFs versus the hedge funds. The corresponding p-values are
reported for each separate variable.
Panel A

Active ETFs

Hedge Funds

-0,014

0,010

0,042

0,033

0,795

0,000

0,284

-0,140

0,069

0,307

0,644

0,000

-0,076

0,164

0,624

0,349

0,632

0,869

Active ETFs
Active ETFs (-1)

Hedge Funds

Hedge Funds (-1)

R-squared
Observations

53

Panel B

Hypothesis Ho: Intercepts are equal

X2

1,175

6,372

p-value

0,001

0,012

31

Figure 1: The figure represents the 5days moving average correlations between the
active (PQZ) and the passive ETF (QQQQ) at the left axis. At the right axis the figure
represents the Nasdaq 100 index. The sample period is since April 16, 2010 and extended
up to March 4, 2010.

32