Swedroe: ‘Passive’ Market Efficiency Works

March 25, 2019

Summary

The shift from active to passive investment strategies has profoundly affected the asset management industry in the past few decades. And since the odds of winning the game of active management continue to persistently shrink (for those interested in the evidence and the causes of the phenomenon, see “The Incredible Shrinking Alpha”), the trend toward passive management seems inevitable. Thus, as the authors note: “Its effects will continue to ripple through the financial system for years to come.”

While the active management industry rails against the evils of passive strategies (even declaring it’s “worse than Marxism”), there’s really no evidence that markets are no longer capable of allocating capital efficiently—there is still plenty of room for active funds to set prices.

My guess is that at least 90% of the active management industry could disappear and the markets would remain highly efficient.

Remember, the markets were doing a pretty good job of allocating capital prior to 1950 when the number of mutual funds first topped 100. That number was still only at about 150 in 1960, and we didn’t seem to have any problems allocating capital efficiently then.

Today there are more than 9,000 mutual funds and more than 10,000 hedge funds. Do investors really need all those active managers to ensure that capital is allocated efficiently? It doesn’t seem likely.

There is one other point to make. At least, as of today, the fact that companies who report better- or worse-than-expected results still see higher volumes and larger same-day price moves implies there are still plenty of investors making the markets highly efficient.

Larry Swedroe is the director of research for The BAM Alliance, a community of more than 130 independent registered investment advisors throughout the country.

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