Active Management is a Negative-Sum Game

Tuesday, September 8, 2020 4,847 views

Comedian and co-host of the Netflix series "100 Humans", Sammy Obeid explains why active investing is a negative-sum game.

To see Sammy's video on Market Efficiency, click here: Investing and Market Efficiency 

To read about Standard & Poors SPIVA Q1 2020 Report click: SPIVA 200 Active vs. Passive Scorecard (Q1)

Active investing, like tic-tac-toe, is a zero sum game. Active management is paying someone to actively invest for you, like paying someone to play tic-tac-toe for you. Unlike tic-tac-toe however, active investing (trying to beat the market return) is a zero sum game relative to a positive expected market return, which is a positive number because shareholders require a fair positive rate of return to hold risky assets. This fair positive expected return is established by the fair market price. The total expected return on the market is still a positive return that is expected to be higher than the fees of active managers. William F. Sharpe summarizes this in his 1991 paper The Arithmetic of Active Management: "If "active" and "passive" management styles are defined in sensible ways, it must be the case that (1) before costs, the return on the average actively managed dollar will equal the return on the average passively managed dollar and (2) after costs, the return on the average actively managed dollar will be less than the return on the average passively managed dollar." As such, the return of the passive portfolio is expected to be higher than that of the active portfolio.

To read the article by William F. Sharpe, click here: The Arithmetic of Active Management


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