The Deadweight Loss of Active Management
40 Pages Posted: 25 Oct 2021
Date Written: October 21, 2021
As most investors hold only one or two funds, the Sharpe ratio is the performance measure relevant for them. Employing this measure, we find that only 13% of active U.S. equity funds outperform the market. We estimate the aggregate annual loss to investors in U.S. active equity funds at $235 Billion. This loss can be decomposed into wealth destruction component of $186 Billion, and a $49 Billion wealth transfer from investors to funds. We discuss possible explanations for the persistence of this large inefficiency, and suggest ways to mitigate it. Employing the Sharpe ratio rather than alpha has a dramatic effect: loss estimates based on alphas are about 10 times smaller.
Keywords: Mutual funds, active management, Sharpe ratio, management fees, investment performance.
JEL Classification: G11
Suggested Citation: Suggested Citation