Get Our Blog
  • Eric Hahn

Why Active Management Comes Up Short

We all know that indexing is cheaper than active management, in which a fund manager selects specific assets for investment. But the question is why has passive investing been so successful during the past few years? Asked differently, why has active management — especially since the financial crisis — had such a dismal run?

Theories abound — none are completely dispositive, but all have some merit in explaining the reasons for underperformance. Let’s consider each:

• Too much competition: As Charles Ellis, a former member of both the Yale endowment fund and Vanguard’s board (our podcast is here), observed:

Gifted, determined, ambitious professionals have come into investment management in such large numbers during the past 30 years that it may no longer be feasible for any of them to profit from the errors of all the others sufficiently often and by sufficient magnitude to beat market averages.

Hence, even a market that is not perfectly efficient quickly eliminates almost all of the potential alpha, or above-market returns. Being smart, hard-working and savvy may create only a short-lived advantage -- or none at all.

• Main Street has given up on Wall Street: The average retail investor over the past 15 years or so has endured the dot-com boom and bust, the housing bubble, a full-blown financial crisis followed by an awful stock-market crash, a whipsawing commodities market and almost zero returns on cash savings. These investors now suffer from finance fatigue and have little interest or faith in anything that Wall Street is selling.

Is it any surprise that many investors, after having been so badly beaten up, have decided to take their ball and go home? And by ball, I mean capital, and by home, I mean low-cost index funds.

• Stricter enforcement of insider trading laws: There’s been a run of finance-industry scandals, a very short list of which ranges from Bernie Madoff’s Ponzi scheme to gaming closing times for mutual funds to spinning initial public offerings. In the past few years, the Justice Department seems to have rediscovered insider trading.

Why? Because it’s a) relatively simple to prosecute; b) there’s often lots of unambiguous evidence and; c) the odds of a conviction are high.

• Internet has leveled the playing field: How much information that once was the province of a select few is now in the hands of all?

It was a huge game-changer when Yahoo message boards begin to fill up with posts from people doing legwork on individual companies. When someone reported that XYZ Tech’s employee parking lots were filled with cars 24/7 — including weekends — anyone paying attention understood that business was booming and that sales were going to beat investor expectations. For the few who grasped that, this was a period of large trading profits.

This advantage exists only when a small number of people know what a large number of people are going to find out too late to act on. Wheneveryone knows, the advantage disappears.

• Too much capital chasing too little alpha: According to Nobel winner William Sharpe, there is only a finite amount of alpha, implying that trading is a zero sum game. Thirty or so years ago, there was greater information asymmetry. When pension and endowment funds were smaller and less invested in alternatives (like hedge funds, venture capital and private equity), there was more alpha to be divvied up among fewer players.

• Alpha is really only factor-based investing: What was once believed to be outperformance might be explained by specific portfolio characteristics, such as momentum, earnings quality and other features. Once these so-called factors and any additional risk are accounted for, the alpha all but disappears.

Nobel Prize winner Eugene Fama and Kenneth French developed the five-factor asset pricing model in which they found that various factors can account for “between 71% and 94% of the cross-sectional variance of expected returns.” In other words, alpha is more the result of these specific factors than most investors realize.

Other theories abound: Active managers have failed to adapt to the unique circumstances of the Federal Reserve’s monetary policy in response to the financial crisis; it’s easier than ever to put together complex, math-driven investment portfolios that would have been impossible in the past; the rise of passive investing is only a temporary shift and eventually the cycle will turn.

I suspect that the changes we have witnessed are of a permanent nature -- active management might again have its day in the sun, but those days will be fewer and further between than they have been in the past.

Portfolio &
Money Management


Contact Us

4 Landmark Square - Suite 315
Stamford, CT 06901





ADV Part 2 | ADV Part 3 (CRS) Privacy Policy | Cyber Security Policy | Business Continuity Plan Client Secure Upload


Check the background of this firm on FINRA’s BrokerCheck.           


NS Capital LLC is a Registered Investment Adviser. NS Capital and its representatives are in compliance with the current filing requirements imposed upon registered investment advisers by those states in which NS Capital maintains clients. NS Capital may only transact business in those states in which it is registered, or qualifies for an exemption or exclusion from registration requirements. NS Capital’s web site is limited to the dissemination of general information pertaining to its advisory services, and through the NS Blog access to additional investment-related information, publications, and links.  Accordingly,  NS Capital’s web site on the Internet should not be construed by any consumer and/or prospective client as NS Capital’s solicitation to effect, or attempt to effect transactions in securities, or the rendering of personalized investment advice for compensation, over the Internet.  Any subsequent, direct communication by NS Capital with a prospective client shall be conducted by a representative that is either registered or qualifies for an exemption or exclusion from registration in the state where the prospective client resides. For information pertaining to the registration status of NS Capital, please contact the SEC or the state securities regulators for those states in which NS Capital maintains a notice filing.  A copy of NS Capital current written disclosure statement discussing NS Capital’s business operations, services, and fees is available from NS Capital upon written request. NS Capital does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to NS Capital’s web site or incorporated herein, and takes no responsibility such content.  All such information is provided solely for convenience purposes only and all users should be guided accordingly.


Please remember that different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment or investment strategy (including those undertaken or recommended by NS Capital), will be profitable or equal any historical performance level(s).


Certain portions of NS Capital’s web site (i.e. newsletters, articles, commentaries, etc.) may contain a discussion of, and/or provide access to, NS Capital (and those of other investment professionals) positions and/or recommendations as of a specific prior date.  Due to various factors, including changing market conditions, such discussion may no longer be reflective of current position(s) and/or recommendation(s).  Moreover, no client or prospective client should assume that any such discussion serves as the receipt of, or a substitute for, personalized advice from NS Capital, or from any other investment professional. NS Capital is neither an attorney nor an accountant, and no portion of the web site content should be interpreted as legal, accounting or tax advice. 


Rankings and/or recognition by unaffiliated rating services and/or publications should not be construed by a client or prospective client as a guarantee that he/she will experience a certain level of results if NS Capital is engaged, or continues to be engaged, to provide investment advisory services, nor should it be construed as a current or past endorsement of NS Capital by any of its clients.  Rankings published by magazines, and others, generally base their selections exclusively on information prepared and/or submitted by the recognized adviser. Each client and prospective client agrees, as a condition precedent to his/her/its access to NS Capital web site, to release and hold harmless , NS Capital’s officers, directors, owners, employees and agents from any and all adverse consequences resulting from any of his/her/its actions and/or omissions which are independent of his/her/its receipt of personalized individual advice from NS Capital.

© 2020-2025 NS Capital LLC. All Rights Reserved.