Active Management’s Role in Market Efficiency in the Spotlight

January 7, 2025

As the Active Managers Council has highlighted since its inception, active management plays an important role in maintaining market efficiency. By actively buying and selling investments, active managers establish market prices, helping to move those market prices closer to the value of the assets underlying the investments. This activity benefits all investors.

The Council is pleased to see that this critical role of active management is getting more attention. In the past few months:

Ken Griffin, founder and CEO of hedge fund Citadel, explained how active investors create the market efficiency that makes passive investing possible. Speaking with David Rubenstein, co-founder and co-chairman of The Carlyle Group, at the George Washington Presidential Library, Griffin expressed frustration with the regulatory burden being placed on active managers by the SEC. Griffin’s remarks were reported in Bloomberg and other news outlets.

Hedge fund Apollo Global Management released a research paper looking at how the rise in passive investing has affected market efficiency. Authored by Felix von Moltke of the University of Oxford together with Apollo Chief Economist Torsten Sløk, this paper also received media attention. It concludes that increased passive investing has contributed to a decrease in market efficiency in the form of reduced price elasticity and market responsiveness, has amplified price movements, and has decreased liquidity. In addition, flows into passive vehicles have led to increased market concentration.

The importance of active management has inspired poetry. Really! In “Oh, The Ironies Your Money Will Know! (The Paradox of Passive Investing),” HumbleDollar blogger Jamie Seckington rhymes:

Oh, index funds have a tale to tell,
Of how they invest and invest quite well.
They’re cheap, they’re easy, they’re widely adored.
But here’s the twist that can’t be ignored:

They lean on the work of those active and wise,
The managers, experts, with sharp, watchful eyes…

So what’s the takeaway from this big rhyme?
That no strategy works all of the time.
Passive or active, they all intertwine.
One leans on the other to function just fine.

Interested in learning more about the relationship between active management and market efficiency? The Active Managers Council has a new web page with educational content and additional resources, including two research papers supported by the Council:

• “Active Investing and the Efficiency of Security Markets” by Russ Wermers describes the mechanisms that translate active managers’ activities into market efficiency.
• “Powering Past ‘Peak Passive’? Insights on the Active-Passive Balance from the Literature on Market Efficiency” by Theresa Hamacher reviews the research findings the relationship between the level of passive investing and market efficiency.