Why Active Investment Management is So Hard

It’s not costs and fees. The problem also isn’t that managers are dumb, according to this article. It summarizes some academic research that largely has been ignored but does a better job of explaining how hard active management is than other approaches. The problem is that stocks actually are a bad long-term investment. A small number of stock with fantastic returns are what drive indexes higher, and it is easy for active managers to miss those stocks.

But beyond that, what stood out to Bessembinder is how lopsided returns really are. Indeed, according to his work, so precious is the performance of the tiny cohort of gainers that it masks that your average stock historically has been a worse investment choice than a one-month Treasury bill.

“At a practical level, skewness matters,” Bessembinder says by phone. “The underlying statistical issue is underappreciated. Even if there weren’t fees and expenses, the odds are you’ll underperform.” According to his findings, roughly 70 percent of stocks will do worse than the Treasury bill, with the rate of performance improving directly with company size. Yet even in the top decile of market capitalization, 30 percent still offer smaller gains than the T-bill.