What Role Does Active Management Play in the Markets?
Active management plays an important role in maintaining market efficiency. In an efficient market, on average, the prices of securities reflect the value of the assets underlying the securities. In addition, in an efficient market, the prices of over- or undervalued securities tend to move toward fair value, rather than further away from it, and prices adjust quickly to changes in value. New information is the primary driver of price change in efficient markets.
More efficient markets have three principal advantages:
- They encourage broader investor participation.
- They make it easier to diversify risk.
- They encourage capital formation.
On the other hand, market inefficiency leads to inefficient decision-making in the real economy which depresses economic growth.
Active management is the driver of market efficiency. Through the buying and selling of investments, active managers establish the market prices for securities. Therefore, an increase in the amount of active management will lead to greater market efficiency.
Actively managed portfolios are also critical to capital formation, since they are buyers of initial public offerings of securities issued by private companies.
All investors benefit from the efforts of active managers.
“Active Investing and the Efficiency of Security Markets” by Russ Wermers, an award-winning research paper sponsored by the Active Managers Council, discusses the relationship between active management and market efficiency. “Power Past Peak Passive: Insights on the Active-Passive Balance from the Literature on Market Efficiency” by Theresa Hamacher reviews the research on the relationship between active management and market efficiency and discusses the implications of the findings.
