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On the Size of the Active Management Industry

Author

Listed:
  • Ľuboš Pástor
  • Robert F. Stambaugh

Abstract

We argue that active management's popularity is not puzzling despite the industry's poor track record. Our explanation features decreasing returns to scale: As the industry's size increases, every manager's ability to outperform passive benchmarks declines. The poor track record occurred before the growth of indexing modestly reduced the share of active management to its current size. At this size, better performance is expected by investors who believe in decreasing returns to scale. Such beliefs persist because persistence in industry size causes learning about returns to scale to be slow. The industry should shrink only moderately if its underperformance continues.

Suggested Citation

  • Ľuboš Pástor & Robert F. Stambaugh, 2012. "On the Size of the Active Management Industry," Journal of Political Economy, University of Chicago Press, vol. 120(4), pages 740-781.
  • Handle: RePEc:ucp:jpolec:doi:10.1086/667987
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    References listed on IDEAS

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    Cited by:

    1. Diane Del Guercio & Jonathan Reuter, 2014. "Mutual Fund Performance and the Incentive to Generate Alpha," Journal of Finance, American Finance Association, vol. 69(4), pages 1673-1704, August.
    2. Ľuboš Pástor & Robert F. Stambaugh & Lucian A. Taylor, 2017. "Do Funds Make More When They Trade More?," Journal of Finance, American Finance Association, vol. 72(4), pages 1483-1528, August.
    3. Nicolae B. Gârleanu & Lasse H. Pedersen, 2015. "Efficiently Inefficient Markets for Assets and Asset Management," NBER Working Papers 21563, National Bureau of Economic Research, Inc.
    4. Pástor, Ľuboš & Stambaugh, Robert F. & Taylor, Lucian A., 2015. "Scale and skill in active management," Journal of Financial Economics, Elsevier, pages 23-45.
    5. repec:eee:jfinec:v:112:y:2014:i:2:p:213-231 is not listed on IDEAS
    6. Marcel Müller & Tobias Rosenberger & Marliese Uhrig-Homburg, 2017. "Fake Alpha," SFB 649 Discussion Papers SFB649DP2017-001, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.
    7. Massa, Massimo & Wang, Chengwei & Zhang, Hong & Zhang, Jian, 2015. "Investing in Low-Trust Countries: Trust in the Global Mutual Fund Industry," CEPR Discussion Papers 10472, C.E.P.R. Discussion Papers.
    8. Markus Ibert & Ron Kaniel & Stijn Van Nieuwerburgh & Roine Vestman, 2017. "Are Mutual Fund Managers Paid For Investment Skill?," NBER Working Papers 23373, National Bureau of Economic Research, Inc.
    9. Berk, Jonathan B. & van Binsbergen, Jules H., 2016. "Assessing asset pricing models using revealed preference," Journal of Financial Economics, Elsevier, pages 1-23.
    10. Glode, Vincent, 2011. "Why mutual funds "underperform"," Journal of Financial Economics, Elsevier, pages 546-559.
    11. Tao Chen & Karen H. Y. Wong & Masayuki Susai, 2016. "Active Management and Price Efficiency of Exchange-traded Funds," Prague Economic Papers, University of Economics, Prague, pages 3-18.
    12. Wagner, Niklas & Winter, Elisabeth, 2013. "A new family of equity style indices and mutual fund performance: Do liquidity and idiosyncratic risk matter?," Journal of Empirical Finance, Elsevier, pages 69-85.
    13. Jeon, Hyunglae & Kang, Jangkoo & Lee, Changjun, 2017. "Precision about manager skill, mutual fund flows, and performance persistence," The North American Journal of Economics and Finance, Elsevier, pages 222-237.
    14. Habib, Michel A. & Johnsen, D. Bruce, 2016. "The quality-assuring role of mutual fund advisory fees," International Review of Law and Economics, Elsevier, pages 1-19.
    15. Lubos Pastor & Robert F. Stambaugh & Lucian A. Taylor, 2017. "Fund Tradeoffs," NBER Working Papers 23670, National Bureau of Economic Research, Inc.
    16. Agarwal, Vikas & Arisoy, Y. Eser & Naik, Narayan Y., 2017. "Volatility of aggregate volatility and hedge fund returns," Journal of Financial Economics, Elsevier, pages 491-510.
    17. Clemens Sialm & T. Mandy Tham, 2016. "Spillover Effects in Mutual Fund Companies," Management Science, INFORMS, pages 1472-1486.
    18. Cheng, Si & Massa, Massimo & Zhang, Hong, 2015. "Short-Sale Constraints and the Pricing of Managerial Skills," CEPR Discussion Papers 10447, C.E.P.R. Discussion Papers.
    19. Diane Del Guercio & Jonathan Reuter & Paula A. Tkac, 2010. "Broker Incentives and Mutual Fund Market Segmentation," NBER Working Papers 16312, National Bureau of Economic Research, Inc.
    20. repec:eee:jfinec:v:125:y:2017:i:2:p:311-325 is not listed on IDEAS
    21. Berk, Jonathan B. & van Binsbergen, Jules H., 2015. "Measuring skill in the mutual fund industry," Journal of Financial Economics, Elsevier, pages 1-20.
    22. repec:eee:jbfina:v:82:y:2017:i:c:p:133-150 is not listed on IDEAS
    23. Robert F. Stambaugh, 2014. "Investment Noise and Trends," NBER Working Papers 20072, National Bureau of Economic Research, Inc.
    24. Clemens Sialm & T. Mandy Tham, 2016. "Spillover Effects in Mutual Fund Companies," Management Science, INFORMS, pages 1472-1486.
    25. Habib, Michel Antoine & Johnsen, D. Bruce, 2015. "The quality-assuring role of mutual fund advisory fees," CEPR Discussion Papers 10438, C.E.P.R. Discussion Papers.

    More about this item

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G20 - Financial Economics - - Financial Institutions and Services - - - General

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