The authors also test whether systematic style exposures might have caused the monthly return deviations of the aggregate of non-total market index funds from the total market index. Their models suggest that systematic factors do explain a noticeable portion of the variability of returns.
Their results showed that, in fact, parts of these return deviations were driven by systematic style exposures. These exposures changed over time, indicating the changing choices made by investors. During the first time period (1995–2009), investors made choices that resulted in an aggregate portfolio of relatively higher beta stocks,1 larger-cap stocks, and value stocks while in the second period (2009–2020), the aggregate investor portfolio consisted of relatively lower-beta stocks and smaller-cap stocks. This shift is another indication that, for many investors, their investment exposure in non-total market index funds is active in nature.
It stands to reason that if investors choose index funds to build truly passive portfolios, the asset-weighted aggregate of all index funds should equal the total market, and every cross-section should be proportional to the comparable subset of the total market.
But that doesn’t hold up. The active nature of the aggregate of non-total market index funds also manifests itself in industry weights that are not aligned with those of the broader U.S. equity market. The magnitude and consistency of the deviations differ by industry. To be clear, no industry was found to have been either underweighted or overweighted over the entire time period. However, deviations were more stable for some industries. For example, real estate has been overweight in 233 out of 313 months observed, while financial services has been underweight in 279 of the 313 months.