Cost Of Active Management: $80 Billion?

by on September 9, 2009

The debate over the merits of active management relative to more passive indexing strategies has been raging for some time. And it’s unlikely that anyone or anything is going to put an end to it at any time in the near future – both sides will always have strong support from different types and classes of investors. But Larry Swedroe recently put out some interesting figures that make a compelling case for passive management and adoption of ETFs in client portfolios.

Because they generally charge higher costs than passively managed exchange-traded funds, active managers must be able to consistently outperform their benchmarks in order to justify the services they provide to investors. Over the years, a number of studies have indicated that the vast majority of active managers fail to capture alpha on a regular basis, meaning that employing an active manager actually costs investors money. But it’s difficult to get too upset about it when there’s no price tag put on it.

How does $80 billion sound?

Citing a 2008 study, “The Cost of Active Investment,” completed by the highly-regarded Professor Kenneth French, Swedroe notes that the cost of investing in 2006 was estimated at 0.75% of the value of all NYSE, Amex, and NASDAQ stocks. But if all investors paid passive fees, the cost of investing would have been 0.09%. “Based on a market capitalization of about $12 trillion, active investors transfer about $80 billion annually from their own wallets to the purveyors of actively managed products and market makers,” writes Swedroe.

Disclosure: No positions at time of writing.