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Winning at Active Management by John Keefe, Michael A. Welhoelter, Steven D. Bleiberg, William W. Priest

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Chapter 6 Active versus Passive Management: The Empirical Case

Given the debate of the past 50 years, we conclude that what might have started off as an ironclad theoretical case for passive management has been worn down by the real-life insights of the behavioral economists. Today a fair observer could say that with all the possible sources of inefficiencies in stocks arising from investor behavior, active managers should be able to add value over a passive strategy—or at least that they have they the raw materials available to them. But what happens in the real world?

A large and diverse investment industry works hard to outperform the broad markets, but the historical record of returns achieved by active managers is mixed. Many times, the average manager falls short, depending on the asset categories, time periods, and market environments considered.

This underperformance is not just a recent phenomenon. At about the same time Robert Shiller was finding exceptions to the Capital Asset Pricing Model (CAPM) and the notion of efficient markets, real-world results were also challenging old beliefs that astute managers could beat the market. In mid-1975 Charles D. Ellis, the founder of Greenwich Associates, a pioneering firm of consultants in investment management, authored an article on the failure of active management, titled “The Loser’s Game.”1 For the three market cycles running from September 1962 to December 1974, he pointed out that:

Not only are the nation’s leading ...

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