French: Presidential address: the cost of active investing

Question 1

four components of costs

Answer 1

1) fees and expenses investors pay for mutual funds (open-end funds, closed-end funds, exchange-traded funds)
2) investment management costs of institutional investors
3) fees investors pay for hedge funds and funds of hedge funds
4) the costs all investors pay to trade

Question 2

cost of active investing

Answer 2

compare the costs to what society would pay if all investors held a passive market portfolio (difference is the cost of active investing)

Question 3

the value-weight combination of all investors’ portfolios is the ..

Answer 3

market portfolio

–> the returns of a small but representative investor holding is the gross return on the market minus the value-weight average of all investors

Question 4

a trading gain for one investor must be a …

Answer 4

loss for another: including their higher fees, expenses, and trading costs, active investors are playing a negative sum game

Question 5

the cost of active investing is overstated in at least 2 ways

Answer 5

1) the fees and expenses measured include management compensation
2) the assumption that most investors switch to a market portfolio in the passive scenario

Question 6

Why do active investors continue to play a negative sum game?

Answer 6

1) misperceptions about investment opportunities
2) overconfidence
3) prestige of own separate account
4) real ability to produce superior returns

Question 7

the total commissions, bid-ask spreads, and other costs of investors pay for trading services must equal the ..

Answer 7

total revenue brokers and dealers receive for those services

Question 8

the growth in trading can be explained by:

Answer 8

reduced costs, negotiated brokerage commissions, electronic trading networks, decimalization of stock prices, and SEC rules to increase market transparency and liquidity