Active Investing and the Efficiency of Security Markets
22 Pages Posted: 9 Apr 2019 Last revised: 22 Apr 2019
Date Written: March 16, 2019
This paper surveys the vast body of literature on the relationship between active investment management and the efficiency of public security markets in the United States, considering both peer-reviewed academic studies and commentary from investment practitioners. The literature broadly indicates that active investment management simultaneously generates value-added for investors — through the bundle of services offered — and makes public security markets more efficient, thereby aligning the incentives of investors in actively-managed funds with the positive externalities that they create for all investors, including investors in passively-managed funds and both index and rules-based ETFs.
Importantly, active managers counteract many of the “misbehaviors” (biases) of other investors. Further, the benefits of active management are amplified in small- and mid-capitalization U.S. stocks, relative to large-capitalization stocks — since active managers, in aggregate, overweight smaller-capitalization issues relative to their representation in capitalization-weighted market benchmarks. In turn, the improved market efficiency afforded by active management especially enhances the ability of small- and mid-sized companies to raise capital for investments in the real economy. And, the improved efficiency serves to appropriately discipline capital expenditures by all corporations through a more efficient stock price and its resulting impact on the cost-of-capital for corporate investments.
Other services provided by active managers to public security markets, beyond providing improved market efficiency (such as the provision of liquidity to other investors), are also discussed. Finally, recent trends in active investment management are presented, followed by some conjectures about the future of active management.
Keywords: Active investment management, market efficiency, mutual funds
JEL Classification: G23, G14
Suggested Citation: Suggested Citation