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 persistence in industry size causes learning about returns to scale to be slow. The industry should shrink only moderately if its underperformance continues.
We are grateful for comments from Andrew Ang, Amil Dasgupta, Lord John Eatwell, Gene Fama, Vincent Glode, Will Goetzmann, Rick Green, Rich Kihlstrom, Ralph Koijen, Kim Min, Dimitris Papanikolaou, Monika Piazzesi, Luke Taylor, Rob Vishny, Guofu Zhou, three anonymous referees, workshop participants at Chicago, Drexel, Emory, Michigan State, Ohio State, Temple, and Wharton, as well as participants in the meetings of the NBER Asset Pricing Program, Western Finance Association, European Finance Association, Cambridge/Penn conference, HEC Finance and Statistics Conference, Institutional Investor conference at the University of Texas at Austin, CFA Annual Conference, and Q-Group. Support as an Initiative for Global Markets Visiting Fellow (Stambaugh) at the University of Chicago is gratefully acknowledged. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.
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. citation courtesy of