William F. Sharpe, Stanford professor, originator of the Capital Asset Pricing Model, and Nobel laureate in Economic Sciences famed for the “Sharpe ratio”—the standard yardstick the financial world uses today to measure risk and return is named after him.
He wrote an article renowned for its brevity, titled “The Arithmetic of Active Management.”
The entire argument requires no supporting data, just two steps of arithmetic:
01. All investors collectively hold the entire market, so the weighted average performance of everyone is simply the market itself;
02. Passive investors get the market itself at zero cost, while active investors pay hefty fees to get that same market. Therefore, the average performance of the active group must be lower than that of the passive group, by exactly the amount of all costs.
The force of this paper lies in the fact that it depends on no historical data; it is a mathematical certainty. Regardless of whether markets rise or fall, and regardless of how the times change, everyone’s results averaged together equal the market’s average return. Passive investors receive that average itself, while active investors, because of the various costs incurred along the way, are destined to receive a discounted version of it. The active group’s overall performance is therefore destined to lag behind the passive group’s.
Overturning an entire industry on a single page—that is a rare feat of efficiency in the history of academia.
He wrote an article renowned for its brevity, titled “The Arithmetic of Active Management.”
The entire argument requires no supporting data, just two steps of arithmetic:
01. All investors collectively hold the entire market, so the weighted average performance of everyone is simply the market itself;
02. Passive investors get the market itself at zero cost, while active investors pay hefty fees to get that same market. Therefore, the average performance of the active group must be lower than that of the passive group, by exactly the amount of all costs.
The force of this paper lies in the fact that it depends on no historical data; it is a mathematical certainty. Regardless of whether markets rise or fall, and regardless of how the times change, everyone’s results averaged together equal the market’s average return. Passive investors receive that average itself, while active investors, because of the various costs incurred along the way, are destined to receive a discounted version of it. The active group’s overall performance is therefore destined to lag behind the passive group’s.
Overturning an entire industry on a single page—that is a rare feat of efficiency in the history of academia.