Emerald Management Review:
The cost of active investing

Abstract:

Purpose - To identify the aggregate net cost of active investing in the USA.

Design/methodology/approach - Takes the costs of passive investing from 1980 to 2006 and compares them with the costs of active investing. Covers the fees and expenses paid for mutual funds (open, closed and exchange-traded); the management costs of institutional investors; fees paid for hedge funds and funds of funds; and trading costs. Standardizes each year's dollar costs by the average capitalization of NYSE, AMEX and Nasdaq stocks during that year.

Findings - Finds that passive investment costs rise significantly with mutual funds, but fall with institutions and fall dramatically from trading. Reveals that active investment costs are at least 67 basis points above those of passive investment, and active investors pay heavily for price discovery.

Research limitations/implications - Assumes passive investors choose a high-fee mutual fund, and institutional investors invest all their US equities to a passive market portfolio, and defined contribution pension fund fees are higher than defined benefit fees; and a turnover of 10% a year. Argues that active investors pay heavily for price discovery. Implies that research should consider if active investors misperceive the comparative returns, and are overconfident or seek 'bragging rights'.

Originality/value - Presents a tour de force of analysis of investment costs and their implications. Good reading for students of investment.

Keywords:

Article Type:

Research paper

Reference:

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