When Indexing Wins and When It Doesn’t in US Equities: Updating and Extending the Purity Hypothesis

Abstract

Indexes tend to beat active managers in the top-performing US equity asset classes and trail active management in the worst-performing US equity categories. It is hypothesized that the reason for this performance pattern concerns style differences between index and active funds. Indexes are more style pure than corresponding actively managed funds. As a result, indexes are harder to beat when their style is in favor and easier to beat when their style is out of favor. This idea is called the Purity Hypothesis. Data is presented showing that the Purity Hypothesis constitutes a reasonable explanation for the performance differences between index and active funds.

TOPICS: Passive strategies, performance measurement