‘If active and passive management styles are defined in sensible ways, it must be the case that:In other words the effort required to actively manage market investments cannot add to the value of the market.
(1) before costs, the return on the average actively managed dollar will equal the return on the average passively managed dollar; and
(2) after costs, the return on the average actively managed dollar will be less than the return on the average passively managed dollar These assertions will hold for any time period. Moreover, they depend only on the laws of addition, subtraction, multiplication and division. Nothing else is required.’
Sharpe is not without hope;
This need not be taken as a counsel of despair. It is perfectly possible for some active managers to beat their passive brethren, even after costs. Such managers must, of course, manage a minority share of the actively managed dollars within the market in question.In their essay Why Active Investing Is a Negative Sum Game Fama & French continue to stress the irrefutable logic of the argument;
active investing in any sector is always a zero sum game - before costs. After costs, active investing is a negative sum game.French puts a $ figure on the losses incurred by active investors;
I compare the fees, expenses, and trading costs society pays to invest in the U.S. stock market with an estimate of what would be paid if everyone invested passively. Averaging over 1980 to 2006, I find investors spend 0.67% of the aggregate value of the market each year searching for superior returns. Society's capitalized cost of price discovery is at least 10% of the current market cap. Under reasonable assumptions, the typical investor would increase his average annual return by 67 basis points over the 1980 to 2006 period if he switched to a passive market portfolio.Warren Buffett also holds the same view;
“In aggregate they (money managers) have under performed indexed funds and it’s the nature of the game, they simply cannot over perform in aggregate. There are too many of them managing too big a portion of the pool.” AGM 1997 – MorningstarIn his 1982 letter to Congress Warren Buffett warned against the excessive exuberance displayed by trading firms in financial markets;
..“The results of these [investments] companies in some ways resemble the activity of a duck sitting on a pond. When the water (the market) rises, the duck rises; when it falls, back goes the duck. The rise and fall of the lake is hardly something for him to quack about. Buffett Partnership Letter 08/07/1964
"We do not need more people gambling in non-essential instruments identified with the stock market in this country, nor brokers who encourage them to do so. What we need are investors and advisors who look at the long-term prospects for an enterprise and invest accordingly. We need intelligent commitment of investment capital not leveraged market wagers. The propensity to operate in the intelligent, pro-social sector of capital markets is deterred, not enhanced, by an active and exciting casino operating in somewhat the same arena, utilising somewhat similar language and serviced by the same workforce."Of course subsequent events serve to prove that the maths was correct.
