Here’s a fact that doesn’t get enough attention: By some counts, up to 86 percent of active funds underperform their benchmark, but by definition 100 percent of truly passive funds underperform theirs. Why is this? Because — unless they are taking some type of an active bet or have zero management and administration costs — they have to fall short of their benchmark.
As the debate over active versus passive investing continues, investors and regulators alike are overlooking a key point: Passive investing wouldn’t make anybody any money without active investing. Passive investors are essentially free riders, piggybacking off active managers at a fraction of the expense it takes to research investment positions. No one in the investment press focuses on this moral hazard or on whether or not this is fair to active investors, who effectively subsidize their passive brethren.
The media question the value of active management, but they never bother to acknowledge that without it passive investment wouldn’t exist, let alone thrive. Passive investors only make money if markets move, and active managers are responsible for those movements.