On the Size of the Active Management Industry

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 learning about returns to scale is impeded by lack of variation in industry size. The industry should shrink only moderately if its underperformance continues.

You may purchase this paper on-line in .pdf format from SSRN.com ($5) for electronic delivery.

This paper was revised on February 12, 2012

Acknowledgments

Machine-readable bibliographic record - MARC, RIS, BibTeX