Active vs. Passive

An active manager is one who thinks he can achieve better results than the market by picking which stocks to own and when to own them. The constant buying and selling of securities increases investor costs as well as the chances of picking a stock that underperforms the market.

A passive manager is one who believes market returns are good returns so he spends all his efforts trying to reduce costs to capture as much of the market’s returns as possible.

The argument over whether active or passive management is better was fought for many decades. However, there is now such overwhelming evidence against active management, that the debate is no longer a viable one. As William Sharp pointed out in his 1991 paper The Arithmetic of Active Management, on average, active managers must under perform the market. To sum up his paper, Dr. Sharpe makes the following points:

Over any specified period of time, the market return will be a weighted average of all the returns on all the securities within the market.

Each passive manager will obtain precisely the market return before costs.

From the above two you can conclude that the average active manager will also obtain precisely the market return before costs. This is so because the market return must equal a weighted average of the returns of the passive and active segments of the market.

If the average returns of both segments are equal before costs and the costs associated with the actively managed segment are higher, then the net performance of the actively managed segment must be lower.

At PIG, we don’t make bets with your money. We recognize market returns are good returns and we invest your money to benefit from those returns over time.