The Life Cycle of Investment Management When 'Today's Alpha is Tomorrow's Beta'

45 Pages Posted: 30 Jul 2018

See all articles by Georgios Magkotsios

Georgios Magkotsios

University of Southern California, Marshall School of Business, Finance and Business Economics Department

Date Written: July 1, 2018

Abstract

I present a model where competition in the asset management industry has positive and negative effects on fund performance. When funds have increasing (decreasing) returns to scale at the industry level, the flow-performance relation is concave (convex). Active funds outperform their benchmark initially. Competition among funds raises the cost of active management and gradually depletes the profitable opportunities in the aggregate. Eventually, the total surplus declines to zero and the average active manager falls behind the benchmark. Aggregate risk is reduced over time through "closet indexing", until all active funds form a scalable pool of passively invested capital.

Keywords: investment management, alpha, returns to scale, flow-performance relation, network externality

JEL Classification: G11, G12, G23

Suggested Citation

Magkotsios, Georgios, The Life Cycle of Investment Management When 'Today's Alpha is Tomorrow's Beta' (July 1, 2018). Available at SSRN: https://ssrn.com/abstract=3206237 or http://dx.doi.org/10.2139/ssrn.3206237

Georgios Magkotsios (Contact Author)

University of Southern California, Marshall School of Business, Finance and Business Economics Department ( email )

Los Angeles, CA
United States

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