On the Size of the Active Management Industry
NBER Working Paper No. 15646
We argue that active management’s popularity is not puzzling despite the industry’s poor track record. Our explanation features decreasing returns to scale: As the industry’s size increases, every manager’s ability to outperform passive benchmarks declines. The poor track record occurred before the growth of indexing modestly reduced the share of active management to its current size. At this size, better performance is expected by investors who believe in decreasing returns to scale. Such beliefs persist because persistence in industry size causes learning about returns to scale to be slow. The industry should shrink only moderately if its underperformance continues.
Published: ĽuboÅ¡ PÃ¡stor & Robert F. Stambaugh, 2012. "On the Size of the Active Management Industry," Journal of Political Economy, University of Chicago Press, vol. 120(4), pages 740 - 781.
This paper was revised on July 25, 2012