On the Size of the Active Management Industry
44 Pages Posted: 6 Jan 2010 Last revised: 24 Jul 2012
Date Written: July 23, 2012
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.
Keywords: active management, returns to scale, learning, mutual funds
JEL Classification: G10, G20
Suggested Citation: Suggested Citation