Smart beta, “smarter” flows

Jie Cao; Jason C. Hsu; Linjia Song; Zhanbing Xiao; Xintong Zhan

doi:10.1016/j.jempfin.2025.101580

Smart beta, “smarter” flows

Jie Cao, Jason C. Hsu, Linjia Song, Zhanbing Xiao, Xintong Zhan^*

^*Corresponding author for this work

Research output: Journal Publications and Reviews › RGC 21 - Publication in refereed journal › peer-review

Abstract

We document that when smart beta ETFs are more actively traded, mutual fund flow sensitivity to multi-factor alphas increases significantly. This evidence is consistent with a friction hypothesis that active smart beta ETF trading reduces the costs of investing in non-market risk factors (e.g., SMB and HML). Consequently, when this friction is diminished, investors reward mutual fund managers more for multi-factor alphas. We show that the results are driven by sophisticated investors, ruling out behavioral explanations. The results are concentrated among mutual funds with high exposures to non-market risk factors. We further find that the gap between CAPM alpha and multi-factor alphas in explaining flows reduces when smart beta ETFs are actively traded. © 2025 Elsevier B.V.

Original language	English
Article number	101580
Journal	Journal of Empirical Finance
Volume	81
Online published	27 Jan 2025
DOIs	https://doi.org/10.1016/j.jempfin.2025.101580
Publication status	Published - Mar 2025
Externally published	Yes

Funding

We would like to thank Kewei Hou (the editor), two anonymous referees, Jawad Addoum, Hendrik Bessembinder, Tarun Chordia, Kent Daniel, Serge Darolles, Bing Han, Harrison Hong, Jennifer Huang, David Ng, Jos\u00E9 Scheinkman, Johan Sulaeman, Matti Suominen, Sheridan Titman, and seminar participants at Cheung Kong Graduate School of Business, China Securities Regulatory Commission, Nanyang Technical University, Peking University, Singapore Management University, and The Chinese University of Hong Kong for helpful comments. We have benefited from the comments of participants at the 5 th CQAsia Annual Conference, the 11 th NUS Annual Risk Management Conference, the China International Conference in Finance, the 2 nd Asian ETF Summit, The Role of Hedge Funds and other Collective Investment Funds in the Modern World, CQA Fall 2017 Conference, the 1 st World Symposium on Investment Research, and the Northern Finance Association Annual Conference. We also acknowledge the 2016 CQAsia Academic Competition Award, the 2017 CQA Academic Competition Award, and the 2018 ETF Research Academy Award by Paris-Dauphine House of Finance and Lyxor Asset Management. The work described in this article was supported by grants from the Research Grant Council of the Hong Kong Special Administrative Region, China (Project No. GRF 14500919, 14501720, 14500621, 15500023) and the National Natural Science Foundation of China (Grant No. 72271061 and 2022hwyq15).

Research Keywords

Smart beta ETFs
Mutual fund flows
Factor model
Friction
Financial innovation

RGC Funding Information

RGC-funded

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10.1016/j.jempfin.2025.101580

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title = "Smart beta, “smarter” flows",

abstract = "We document that when smart beta ETFs are more actively traded, mutual fund flow sensitivity to multi-factor alphas increases significantly. This evidence is consistent with a friction hypothesis that active smart beta ETF trading reduces the costs of investing in non-market risk factors (e.g., SMB and HML). Consequently, when this friction is diminished, investors reward mutual fund managers more for multi-factor alphas. We show that the results are driven by sophisticated investors, ruling out behavioral explanations. The results are concentrated among mutual funds with high exposures to non-market risk factors. We further find that the gap between CAPM alpha and multi-factor alphas in explaining flows reduces when smart beta ETFs are actively traded. {\textcopyright} 2025 Elsevier B.V.",

keywords = "Smart beta ETFs, Mutual fund flows, Factor model, Friction, Financial innovation",

author = "Jie Cao and Hsu, {Jason C.} and Linjia Song and Zhanbing Xiao and Xintong Zhan",

year = "2025",

month = mar,

doi = "10.1016/j.jempfin.2025.101580",

language = "English",

volume = "81",

journal = "Journal of Empirical Finance",

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TY - JOUR

T1 - Smart beta, “smarter” flows

AU - Cao, Jie

AU - Hsu, Jason C.

AU - Song, Linjia

AU - Xiao, Zhanbing

AU - Zhan, Xintong

PY - 2025/3

Y1 - 2025/3

N2 - We document that when smart beta ETFs are more actively traded, mutual fund flow sensitivity to multi-factor alphas increases significantly. This evidence is consistent with a friction hypothesis that active smart beta ETF trading reduces the costs of investing in non-market risk factors (e.g., SMB and HML). Consequently, when this friction is diminished, investors reward mutual fund managers more for multi-factor alphas. We show that the results are driven by sophisticated investors, ruling out behavioral explanations. The results are concentrated among mutual funds with high exposures to non-market risk factors. We further find that the gap between CAPM alpha and multi-factor alphas in explaining flows reduces when smart beta ETFs are actively traded. © 2025 Elsevier B.V.

AB - We document that when smart beta ETFs are more actively traded, mutual fund flow sensitivity to multi-factor alphas increases significantly. This evidence is consistent with a friction hypothesis that active smart beta ETF trading reduces the costs of investing in non-market risk factors (e.g., SMB and HML). Consequently, when this friction is diminished, investors reward mutual fund managers more for multi-factor alphas. We show that the results are driven by sophisticated investors, ruling out behavioral explanations. The results are concentrated among mutual funds with high exposures to non-market risk factors. We further find that the gap between CAPM alpha and multi-factor alphas in explaining flows reduces when smart beta ETFs are actively traded. © 2025 Elsevier B.V.

KW - Smart beta ETFs

KW - Mutual fund flows

KW - Factor model

KW - Friction

KW - Financial innovation

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U2 - 10.1016/j.jempfin.2025.101580

DO - 10.1016/j.jempfin.2025.101580

M3 - RGC 21 - Publication in refereed journal

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VL - 81

JO - Journal of Empirical Finance

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M1 - 101580

ER -

Smart beta, “smarter” flows

Abstract

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Research Keywords

RGC Funding Information

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