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Explore Cutting Edge Index Investment Research

We provide links to published and working papers related to index investing. Search by topic, keywords, or author. If you would like to add a paper to the Research Library, please fill out the following form: Four Corners' Research Library Contribution. Our team reviews submissions regularly to ensure quality and updates the Research Library with submissions once they are approved.

Research Library: Collections

Off Target: On the Underperformance of Target-Date Funds

David C. Brown, Shaun William Davies

Working Paper

Target-date funds (TDFs) are popular vehicles that provide investors with an evolving asset allocation to meet their needs at some future date (e.g., retirement). While TDFs provide investors with extensive diversification and active rebalancing, TDFs are also a type of fund-of-funds. As such, investors pay multiple layers of fees as most TDFs charge fund-of-funds' fees and also hold funds that collect additional fees. We show that TDFs are easy to emulate with a portfolio of cost-efficient exchange-traded funds (ETFs) and we coin these portfolios Replicating Funds (RFs). RFs substantially outperform TDFs, exhibit low tracking error, do not suffer from cash drag, and require infrequent rebalancing. Our analysis shows that TDF sponsors collectively charged nearly $2.5 billion in excess fees in 2017 alone. We provide a normative rule-of-thumb for investors to construct their own RFs using low-cost ETFs.

Target-Date Fund, Exchange-Traded Fund, Financial Planning

Index-Linked Trading and Stock Returns

Shaun William Davies

Working Paper

I consider a model of index-linked trading in which a fraction of investors trade an index product that holds the market portfolio (e.g., an ETF). The remaining investors build portfolios by evaluating stocks individually. Investors are equally informed and choose portfolios to maximize their expected utility. In equilibrium, price impact from trading the index product is not equal across stocks. Index-linked trade generates cross sectional differences in returns and volatilities. Furthermore, uncertainty about indexing demand generates risk premiums in expected returns and their magnitudes depend on firm fundamentals. The findings lend theoretical support to existing studies and provide new predictions.

Index investing, price impact, cross section of returns

Moral Hazard in Active Asset Management

David C. Brown, Shaun William Davies


We consider a model of active asset management in which mutual fund managers exert unobservable effort to earn excess returns. Investors allocate capital to actively managed funds and passively managed products. In equilibrium, investors are indifferent between investing an additional dollar with an active manager or with a passively managed product. As passively managed products become more attractive to investors, active managers’ revenues from portfolio-management services fall, reducing their effort incentives. More-severe decreasing-returns-to-scale are also associated with reduced incentives and increased moral hazard. Performance-based fees and holdings-based data are all unlikely to mitigate moral hazard.

Mutual funds, Moral hazard, Active management, Passive management

ETF Arbitrage, Non-Fundamental Demand, and Return Predictability

David C. Brown, Shaun William Davies, Matthew Ringgenberg


Non-fundamental demand shocks have significant effects on asset prices, but observing these shocks is challenging. We use the exchange-traded fund (ETF) primary market to study non-fundamental demand. Unique to the ETF market, specialized arbitrageurs called authorized participants correct violations of the law of one price between an ETF and its underlying assets by creating or redeeming ETF shares. We show theoretically and empirically that creation and redemption activities (ETF flows) provide signals of non-fundamental demand shocks. A portfolio that is short high-flow ETFs and long low-flow ETFs earns excess returns of 1.1–2.0% per month, consistent with non-fundamental demand distorting asset prices away from fundamental values. Moreover, we show non-fundamental demand imposes non-trivial costs on investors, leading to underperformance.

Speculation Sentiment

Shaun William Davies


I exploit the leveraged exchange-traded funds' (ETFs') primary market to measure aggregate, uninformed, gambling-like demand, that is, speculation sentiment. The leveraged ETFs' primary market is a novel setting that provides observable arbitrage activity attributed to correcting mispricing between ETFs' shares and their underlying assets. The arbitrage activity proxies for the magnitude and direction of speculative demand shocks and I use it to form the Speculation Sentiment Index. The measure negatively relates to contemporaneous market returns (e.g., it is bullish in down markets) and negatively predicts returns. The results are consistent with speculation sentiment causing market-wide price distortions that later reverse.

investor sentiment, non-fundamental demand, return predictability, leveraged exchange-traded fund

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