Monday, May 14, 2012

Smart money and dumb money:
If, on average, mutual funds underperform the market and, on average, index funds match market performance (that's their goal, after all), then there is some other set of market participants who are, on average, outperforming the market. Presumably, these are professionals with some advantage relative to mutual fund managers - superior market information, superior execution capabilities, etc. The focus of equity market reforms since the 1980s has been to police these advantages - deregulating commissions, allowing for the development of crossing networks (used by the biggest mutual funds as well as other large investors) in order to avoid paying a full spread to market-makers and specialists, etc. But these reforms do not appear to have improved the performance of active mutual funds; rather, the advantages accruing to professional traders (such as high-frequency trading shops) only appear to have grown, with the cost being born by other market participants.


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