The Bad Arithmetic of Active Management

Abstract

There is an ongoing debate over the merits of active portfolio management. Although this article does not settle that debate, the author helps frame issues related to whether active management can make sense for a particular individual or institution. By deconstructing William Sharpe’s “The Arithmetic of Active Management,” (Financial Analysts Journal 1991) a classic article in the active/passive debate, the author illustrates the various sources of value from active management and sheds light on the question of when active managers have a higher likelihood of outperforming or underperforming their benchmarks. Monetary policy is a key determinant; easy money can make investing hard for active managers.