Disillusioned with the performance in active funds, investors are now relying on passive, beta-index exchange traded funds to capture market returns.
Morningstar analyst Michael Rawson argues that common sources of return actually explains the outperformance once attributed to skill in active management.
“Old-fashioned market beta provides the bulk of return–hence, our conclusion that investors should be perfectly content with a fund that provides nothing but beta,” Rawson writes for Morningstar. “It is clear that beta provides the majority of return, even among funds that manage to capture significant alpha.”
Looking at historical data in a capital asset pricing model, or single-factor model, the average monthly return for passive funds was 1.01%, with 0.97 percentage points of the monthly return attributed to market beta and just 0.04 percentage points attributed to alpha, or outperformance.
Meanwhile, in a multi-factor model, alpha for passive funds came in at a negative 0.01 percentage points, which suggests that all the return was provided by exposure to beta factors.