Skill and Fees in Active Management
Greater skill of active investment managers can mean less fee revenue in a general equilibrium. Although more-skilled managers earn more revenue than less-skilled managers, greater skill for active managers overall can imply less revenue for their industry. Greater skill allows managers to identify mispriced securities more accurately and thereby make better portfolio choices. Greater skill also means, however, that active management corrects prices better and thus reduces managers' return opportunities. The latter effect can outweigh managers' better portfolio choices in equilibrium. Investors then rationally allocate less to active funds and more to index funds if active management is more skilled.
I am grateful for comments from Lubos Pastor, Vincent Glode, and participants in the LSE/FCA/SEBI "Paying for Efficient and Effective Markets" conference, the meeting of the French Finance Association, and seminars at Baruch College, the University of Kansas, the University of Pennsylvania, and the University of South Carolina. The views expressed herein are those of the author and do not necessarily reflect the views of the National Bureau of Economic Research.