How different would the movie Hot Tub Time Machine have been if it had not been four loveable losers who got transported back 24 years but four Wall Street types? Before you spend too much time pondering that, relax: The Big Question, our monthly video series, is back from summer break with an answer.
In the movie, the four are taken back to a riotous weekend at a ski resort, where much zaniness ensues and they right some wrongs along the way. Now, replace the protagonists with active fund managers, remove the wacky antics, and swap the ski resort for the stock market, and what do you get?
You'd get active traders with today's techniques and know-how in an environment where they would be much more skilled than their peers. The result might not make for a good comedy, but it would be a way to make a serious amount of money.
The implication is that active fund managers are becoming more skilled at investing. That may sound uncontentious, but it goes against the grain, since investors are putting more and more cash into big passive funds, such as Dimensional Fund Advisors, BlackRock, and Vanguard, the last of which now has almost $3 trillion in assets under management.
Much of the shift to index investing is inspired by research by academics such as Nobel Laureate and Chicago Booth Professor Eugene F. Fama, which suggests that active managers who generate above-average returns are merely lucky, rather than supremely skilled.
The basic question is this: If active managers are becoming more skilled, why aren't they cleaning up?
Well, because—sadly—there is no hot-tub time machine. As Chicago Booth Professor Lubos Pastor explains in the video (and in this article), active managers as a breed are becoming more skilled, so the level of outperformance needed to generate superior returns is rising all the time.
Admittedly, none of this is as hilarious as Hot Tub Time Machine, but there is a joke about passive investing that is always worth repeating: A senior manager at an index fund sees a younger colleague doing something he shouldn't be. The veteran chides, "Don't just do something—sit there!"