Why Do Investors Favor Active Management … To the Extent They Do?

Abstract

Half a century of analysis has yet to fully answer why investors place such a large proportion of their funds with active equity managers, given the discouraging evidence on the latter’s ability to add net value. From the voluminous literature on manager performance we conclude that there is some, but limited, evidence that can rationally justify hiring active managers. The weakness of the evidence leads us to ask, Why do investors favor active equity management to the extent they do? To help answer this question, we conducted two online surveys, one of Chief Investment Officers of predominantly large Australian superannuation (i.e., pension) funds and another of asset consultants. The results confirmed that the industry is captive to a pervasive prior towards active management. The prior is reinforced by a competitive environment and supported by a complex mix of behavioral, agency, organizational, and cultural factors.

Keywords: Active Management, Agency Costs, Behavioral Finance, Pension Fund, Retirement Savings