An empirical study on actively managed mutual funds vis-à-vis passively managed ETFs using modern portfolio theory

Abstract

The battle between actively managed funds and passively managed funds has been part of the investing environment for roughly the past three decades. Mutual Funds have been around for about a century but with the introduction of Exchange Traded Funds in the 1990s, a significant predicament arose of whether investors should invest in actively managed funds or in passively managed funds. The debate has led many analysts to carry out research on this topic, and while the majority agree that passively managed funds are the optimal choice, some researchers disagree. This research has been carried out in order to try to answer this question and offer more insight to the debate. The research has also applied this debate to different risk profiles in order to see if one strategy is more beneficial to either risk-averse, risk-neutral or risk-seeking investors. The research examines the risk-adjusted returns of actively managed funds and passively managed funds by analysing 2,673 funds, comprising of Fixed Income Mutual Funds, Equity Mutual Funds, Fixed Income Exchange Traded Funds and Equity Exchange Traded Funds, which are all separated according to currency, being Euro, UK Pound and USD Dollar, specifically by constructing twelve equally weighted equity fund portfolios for the period between January 2010 and March 2020. Risk-adjusted returns are also examined with respect to different risk profiles, being risk-averse, risk-neutral and risk-seeking. In order to carry out this research a model was created by using Microsoft Excel which is based on the Modern Portfolio Theory. In order to obtain the optimal risk-adjusted returns, optimisations were conducted on the portfolios. The research concluded that passively managed funds, in this case, Exchange Traded Funds, did not perform better than actively managed funds, in this case Mutual Funds, for risk-adjusted returns. However, it is critical to take into account that superior costs are often linked with the actively managed funds. Therefore, it would not be prudent to generalise that any one from either passively managed funds or actively managed funds is inherently superior to its respective counterpart, but rather to determine accordingly on a case-by-case basis. Subsequently, borrowers are subliminally advised that on average, passive approaches are more cost-effective because ETFs have higher tax advantages. Categorically important for investors is access to the cheapest investing strategy available for their investing target, regardless of whether they are in procession of a passively managed fund or an actively managed fund.