Fiduciary Finance

Fiduciary Finance

Investment Funds and the Crisis in Financial Markets

Martin Gold

This multi-faceted analysis of institutional investment defines ‘fiduciary finance’ institutions as the third pillar of the financial system, alongside banks and insurers. It documents the role played by investment funds and the money management industry during the recent financial crisis, and provides an unashamedly critical review of the business disciplines which can dominate investment practices. It clarifies the economic significance of the investment industry (circa $60 trillion in assets) and the features which differentiate fiduciary finance from traditional financial institutions such as banks and insurers.

Chapter 5: The Active versus Passive Debate

Martin Gold

Subjects: economics and finance, money and banking

Extract

INTRODUCTION Within the fiduciary finance industry and academe, the ‘active versus passive debate’ subjects the economic merits of active investment strategies to continuous and unrelenting scrutiny. This empirical research originating in the mid 1960s questions whether fund managers can add value compared to the market averages. The consensus emerging from this voluminous literature is that active management is economically suboptimal because it delivers inferior returns compared to market indices (which are unmanaged). Moreover, learned financial economists assert that active management must underperform market indices after the costs of management are taken into account.1 These arguments have achieved considerable intellectual momentum and, as a result, the economic rationale of human judgment2 in portfolio management has been queried within academic, practitioner and consumer spheres. Without the specter of this debate, many stakeholders would be likely to adopt a pragmatic view that active portfolio management is essential given differing client constraints, and especially since market indices do not measure investment merit or quality. Without a rebuttal to this formidable challenge, only index-tracking strategies (which mimic indices and have very low operating costs) appear to have any economic justification. Fund managers promoting active management strategies face potentially significant revenue losses if clients adopt index-tracking schemes: confirming the merits of active portfolio management remains a commercial imperative. The debate has deeply paradoxical and contradictory underpinnings. Within the theoretical framework, the literature is used to validate the canon of ‘informational efficiency’ and related beliefs that security prices reliably discount all publicly available information. As Fama (1965)...

You are not authenticated to view the full text of this chapter or article.

Elgaronline requires a subscription or purchase to access the full text of books or journals. Please login through your library system or with your personal username and password on the homepage.

Non-subscribers can freely search the site, view abstracts/ extracts and download selected front matter and introductory chapters for personal use.

Your library may not have purchased all subject areas. If you are authenticated and think you should have access to this title, please contact your librarian.

Further information