Exchange-traded funds are synonymous with passive investing. A basic passive portfolio only requires a handful of broad funds to cover most asset classes and countries. Yet, there are now more than 2,500 U.S.-listed ETFs. Most ETFs are closet active vehicles targeting a sector, theme, country or strategy. For example, one of the fastest-growing funds in 2021 has been the Financial Select Sector SPDR Fund (ticker: XLF). It has received approximately $9.5 billion in inflows, expanding its units outstanding by 35% year to date (Oct. 31).
XLF is passively managed, diversified and low cost. But buying XLF or any sector fund is not a passive choice because a broad index investor already has proportionate exposure to financial companies. It is an active decision that financial stocks will outperform the market. Trading XLF replaces stock picking with sector picking. This is also true for thematic and country funds — they are traded to express active views. Narrow products run contrary to the "own everything" approach that the pioneers of passive championed.
We estimate investor activity and the result of their market timing by studying money flows in and out of ETFs. Our analysis indicates that ETF investors have similar behavioral biases of return-chasing that mutual fund data has long showed. An ETF structure might be passive, but humans are not.