Active and Passive Investing: Understanding Samuelson's Dictum
68 Pages Posted: 15 Oct 2018 Last revised: 26 Aug 2021
Date Written: August 1, 2021
We model how investors allocate between asset managers, managers choose portfolios of multiple securities, fees are set, and security prices are determined. Investors are indifferent between higher-cost informed managers and lower-cost uninformed managers, interpreted as passive managers as their portfolio is linked to the "expected market portfolio." We make precise Samuelson's dictum by showing that active investors reduce micro-inefficiencies more than they do macro-inefficiencies. In fact, all inefficiency arises from systematic factors when the number of assets is large. Further, we show how the costs of active and passive investing affect macro- and micro-efficiency, fees, and assets managed by active and passive managers. Our findings help explain the rise of delegated asset management and the resultant changes in financial markets.
Keywords: asset pricing, market efficiency, asset management, search, information
JEL Classification: D4, D53, D8, G02, G12, G14, G23, L1
Suggested Citation: Suggested Citation