The Value of Active Investing

Volume 13, Number 3, Third Quarter 2015
Craig French

We examine whether the value of active investment management can exceed its cost, and find that it can, by a substantial margin. We consider the 0.67% average cost estimate in French (2008), comparing it with the expected value of a known active investment strategy. For a “passive” benchmark, we develop a 225 year index of monthly U.S. equity market returns, from July 1789 through June 2014. This timeframe encompasses the entire history of every U.S. exchange and includes all known periods of secondary market stock trading in the United States. We then estimate the long-run monthly returns of an active investment strategy based on an actual 11-year investment strategy. We present a new performance model extending the Treynor and Mazuy (1966) model and implement it to estimate monthly returns to the active strategy over the same 225 year period.We believe that this experiment offers a good example of how the value of well-constructed active investment strategies can be worth substantially more than their cost.