There really is an issue on which economists are unanimous, a big issue to boot.
Source: Diversified Investing | IGM Forum.
Actively-managed mutual funds cannot earn excess returns over index funds because in aggregate they earn the same as index funds, less the difference in cost. This was proposed by Sharpe in his timeless 1991 article, The Arithmetic of Active Management.
Of course, certain definitions of the key terms are necessary. First a market must be selected — the stocks in the S&P 500, for example, or a set of “small” stocks. Then each investor who holds securities from the market must be classified as either active or passive.
- A passive investor always holds every security from the market, with each represented in the same manner as in the market. Thus if security X represents 3 per cent of the value of the securities in the market, a passive investor’s portfolio will have 3 per cent of its value invested in X. Equivalently, a passive manager will hold the same percentage of the total outstanding amount of each security in the market2.
- An active investor is one who is not passive. His or her portfolio will differ from that of the passive managers at some or all times. Because active managers usually act on perceptions of mispricing, and because such misperceptions change relatively frequently, such managers tend to trade fairly frequently — hence the term “active.”
… Properly measured, the average actively-managed dollar must underperform the average passively-managed dollar, net of costs. Empirical analyses that appear to refute this principle are guilty of improper measurement.
In 2008, Warren Buffett made a bet of $1 million with Protégé Partners LLC that, including fees, costs and expenses, an S&P 500 index fund would outperform a hand-picked portfolio of hedge funds over the 10 years ending December 31, 2017.