Allocating between Active and Passive Management

Eric H. Sorensen, Keith L. Miller and Vele Samak

Financial Analysts Journal, 1998, vol. 54, issue 5, 18-31

Abstract: With the recent difficulty in beating the S&P 500 Index, the debate over active versus passive investing has risen to a new level of importance. We provide a framework for analyzing the trade-off the typical pension fund faces in deciding how much to index. Our analysis gets at the root of active performance—stock-picking skill. After analyzing the performance associated with various degrees of skill in various equity styles for the 1985–97 period, we found that a modest amount of stock-picking skill goes a long way and that the optimal amount of allocation to indexing declines as skill increases. For most risk categories, however, some allocation to indexing is appropriate.

Date: 1998
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DOI: 10.2469/faj.v54.n5.2209

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