The Tale of Two Irrationalities: Why Money Managers Keep Promising What They Cannot Deliver and Why Clients Keep Giving Them Their Money
33 Pages Posted: 5 Jun 2017
Date Written: June 3, 2017
It appears intuitively plausible that actively managed funds by investment professionals should do better than a naïve strategy of buying a market index, which any uninformed person can do at much lower cost than paying a professional manager. However, the evidence points to the contrary: professional managers are not able to beat the index consistently and investors do not cease to patronize the services of those money managers. This paper reviews the overwhelming evidence that average investors engaged in passive indexing can do much better using the naïve approach on their own than soliciting the help of professional active portfolio managers. After questioning the ethics of charging fees for active management only to yield below average results, we examine some of the traditional explanations of this enigma. We then offer some behavioral explanations as to why this problem has persisted in the market for so long and discuss some possible behavioral-based policy prescriptions that may help to rectify this apparent market dysfunction.
Keywords: Market Index, Active Management, Closet Indexing, Management Fees
JEL Classification: G02, G11 G12, G18, G24
Suggested Citation: Suggested Citation