Looking for Easy Games – How Passive Investing Shapes Active Management
“As they say in poker, ‘If you’ve been in the game 30 minutes and you don’t know who the patsy is, you’re the patsy.’” –Warren E. Buffett
- Investors are rapidly shifting their investment allocations from active to passive management. This trend has accelerated in recent years.
- The investors leaving active managers are likely less informed than those who remain. This is equivalent to the weak players leaving the poker table. Since the winners need losers, this can make the market even more efficient, and hence less attractive, for those who remain.
- Active management provides price discovery and liquidity, valuable social goods. However, the fees are higher for active managers than passive ones, identifying skill ahead of time is not easy, and there is a cost to assessing skill.
- Passive management has lower costs and hence higher returns per dollar invested than active management does in the aggregate. But passive management introduces the possibility of market distortions.
- Active managers have to constantly ask, “Who is on the other side?” The unrelenting objective is to find easy games, where differential skill pays off.
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