With short-sellers undermining managers’ positions and adding to active funds’ widespread under-performance, investors may be better off capturing market returns through a passive index-based exchange traded fund.

According to the working paper, Do Short-Sellers Profit from Mutual Funds? Evidence from Daily Trades, by accounting and finance professors at Indiana and Standford universities, short sellers consistently bet against mutual fund, profiting from mutual fund flows, reports Joe Morris for Ignites. [Active Stock Pickers Trail Passive S&P 500 ETFs]

“A curious finding from past studies is that active MFs [mutual funds]consistently underperform their passive benchmark,” according to the authors. “We show that at least some of this underperformance is potentially attributable to a net wealth transfer between MFs and SSs [short sellers].”

While fund companies have been trying to engage in “stealth trading” and build “more skillful trading desks,” the efforts have not paid off in hiding their positions. “MFs are still telegraphing their trades to some SSs,” the authors added.

Specifically, the authors point to diverging performances on days when short-sellers bet against mutual funds. They found that over a 63-day holding period, returns on a short-selling strategy that mutual funds and short sellers disagree upon earned 1.98%, whereas a short-selling strategy that mirrored mutual fund behavior earned 0.57%. [Stock ETF Rally Could Find Help From Underperforming Active Funds]