Investing in Pseudo-Science : The Active Versus Passive 'Debate'

The debate about the merit of active or passive investment management encompasses a large body of empirical literature which generally shows that actively-managed portfolios underperform the market. This research is presented as scientific evidence that active management does not have any economic rationale. The efficacy of this debate has largely gone unchallenged. Unlike previous literature, this paper directly scrutinizes the debate's empirical methodology and argues that the rationale it provides for indexing tracking strategies is mistaken. This paper also examines the consequences of indexing strategies and the debate's profound effects on institutional investors. In terms of explaining market failures and predicting security prices, these aspects may be of equal significance to financial fundamentals themselves. This critique is of obvious importance to active managers who have a vested interest in answering this debate, and also to finance scholars because the debate's empirical foundation supports important precepts of investment theory