Does Active Management Provide Investor Surplus?

Abstract

A consumer experiences consumer surplus when she pays less than her reservation price for a product. Similarly, an investor experiences investor surplus when he would be willing to pay more than the charge to invest in a particular instrument or portfolio. Typically, a portfolio manager generates investor surplus by delivering alpha. Jacobsen formally shows in this article that a portfolio manager can also generate investor surplus by having asymmetric betas, that is, when the beta in up markets is different than the beta in down markets. Because no one forces investors to buy active management, they must perceive benefits that exceed the cost. Some of these benefits (custody, diversification, accounting, partial share ownership) are also available from passive strategies; others (expected differences in up and down market betas, alphas, optionality, cocktail party conversation) are only available from active management.