Active and Passive Investing

45 Pages Posted: 15 Oct 2018 Last revised: 21 Feb 2019

See all articles by Nicolae Garleanu

Nicolae Garleanu

University of California, Berkeley - Haas School of Business; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Lasse Heje Pedersen

AQR Capital Management, LLC; Copenhagen Business School - Department of Finance; New York University (NYU); Centre for Economic Policy Research (CEPR)

Date Written: February 2019

Abstract

We model how investors allocate between asset managers, managers choose their portfolios of multiple securities, fees are set, and security prices are determined. The optimal passive portfolio is linked to the “expected market portfolio,” while the optimal active portfolio has elements of value and quality investing. We make precise Samuelson's Dictum by showing that macro inefficiency is greater than micro inefficiency under realistic conditions - 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 empirical facts about the rise of delegated asset management, the composition of passive indices, and the resulting 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

Garleanu, Nicolae Bogdan and Pedersen, Lasse Heje, Active and Passive Investing (February 2019). Available at SSRN: https://ssrn.com/abstract=3253537 or http://dx.doi.org/10.2139/ssrn.3253537

Nicolae Bogdan Garleanu

University of California, Berkeley - Haas School of Business ( email )

545 Student Services Building, #1900
2220 Piedmont Avenue
Berkeley, CA 94720
United States

HOME PAGE: http://faculty.haas.berkeley.edu/garleanu

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Lasse Heje Pedersen (Contact Author)

AQR Capital Management, LLC ( email )

Greenwich, CT
United States

Copenhagen Business School - Department of Finance ( email )

Solbjerg Plads 3
Frederiksberg, DK-2000
Denmark

New York University (NYU) ( email )

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

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