Does Active Management Pay? New International Evidence

Abstract

We hypothesize and find that the value of active management depends on characteristics of markets and investors. Using unique data, we focus on the performance of actual passive and active equity positions of an important category of institutional investors (defined benefit pension plans) from 1993 to 2008. After accounting for a variety of possible risk-based explanations, we conclude that in non-US equities there are no net costs to active positions and some evidence of benefits. In emerging markets, tests indicate significant active outperformance of 250 basis points per year. In EAFE markets, outperformance is around 50 basis points per year although in some of our tests this is not significantly different from zero. In more efficient US markets, consistent with prior studies, active positions underperform by the amount equal to the difference in active and passive costs. One implication of these patterns in returns is that plan managers will be more inclined to use active strategies in non-US markets. We test this implication and find that plans are the least active in US equities, more active in EAFE equities and the most active in emerging markets, and that these effects have become more pronounced over time.

Keywords: international financial markets, investment management, emerging markets, active, passive, pension funds

JEL Classification: G11, G14, G15, G23