If it's so hard to beat the market, why do banks invest billions in active portfolio management (and why do they have any customers?) [duplicate]

Question

It's well known that beating the market is difficult, and most actively managed funds aren't really doing all that much better, especially after accounting for fees.

So if that's the case, why the hell do banks invest so much money in active asset management, why do portfolio managers even exist, and why do these people get any customers? Who is it out there that says "yup, I'm going to take all of this money, and NOT invest it in a index-linked mutual fund, but instead give it to some guy in a suit pretending to be an expert and demanding expensive fees just so he can offer me the exact same return I'd get from the S&P 500"?

And now I bet somebody will say "SOME managed funds do beat the market, just look at A, B, and C", yeah buddy that's called survivorship bias. Come back in 5 years and we'll be talking about fund x, Y, and Z.

Answer 1

We had a question on this site just a few days ago:

Why buy index funds when they are guaranteed to underperform their index?

The usual argument is that it is difficult for individual investors to beat stock market indexes. I don't understand this defeatist attitude. As far as I am aware, buying index funds guarantees defeat; it guarantees underperformance relative to the index due to fees, even if there are no other tracking errors.

Their premise is that it doesn't make sense to buy an index fund because it will always do worse than the index.

You take the other premise, why spend the time, effort and money to maybe beat the index sometimes.

And that is why managed funds exist, and why there are all kinds of funds, and many full service brokers that will sell you advice, or will provide tools to do your own analysis. It is also why there are index funds, and funds that automatically evolve when you near retirement age, or when your kid is approaching high school.

Just as people can handle risk differently, they also want to allocate different amounts of time to picking, and managing their investment.

It is true with everything. There are some people that buy a computer off the shelf at a big box store; some people go to the manufacturers website and make choices; others order individual parts and build it at home. The different approaches exist because they measure risk differently and they allocate their time, effort, and money differently. None of the groups are wrong.

Answer 2

Here is one thing noone tells you so far in the answer: Because they CAN.

It may be hard, but there are a TON of people on the planet. Some are the best. They work on that for tons of money. Done.

See, "if it is so hard to be a tennis pro, why do people do it"? Because SOME ARE THE BEST and those get paid BIG BUGS.

Have you seen what high level traders get paid? It is not like big banks need brutally large departments doing that - they need a couple of good people (like Ferrari needs 2 drivers for Formula 1, not thousands) and then - well, there is plenty of money there.

Answer 3

And now I bet somebody will say "SOME managed funds do beat the market, just look at A, B, and C", yeah buddy that's called survivorship bias. Come back in 5 years and we'll be talking about fund x, Y, and Z.

Well that's the answer.

Fund X, Y and Z have different investors, individuals that were betting that the fund they participate in will beat the market. Because it can happen, not will, just can. Whereas buying an index fund guarantees that you will almost match the market, whether thats up, down or sideways.

There is the possibility that if the fund they are in beats the market so well, that they don't have to worry about what happens in five years, or over a long period of time, because they simply made so much money.

There is a bet that the fund manager has access to knowledge and opportunities and tools not available to passive funds. It isn't always profitable, it usually doesn't beat the market, there is a chance that it can beat the market by orders of magnitude, and this provides a service to everyone else that doesn't have the time, knowledge, opportunities and tools.

Remember: Long term investments are short term investments gone wrong.

Answer 4

As for why they have customers: people pay for all sorts of services that don't provide much value, simply because marketers pimp the services and try to create the illusion that they do provide value. People pay for insurance on appliances, psychic readings, and snake-oil "expert" advice on all sorts of matters, all of which is mostly hokum, but they still pay for it. So the problem of people paying for useless (or at least overpriced) services is not unique to the investment world.

In addition, before the 1970s index funds did not exist, and only gradually became more common. Thus there is still a fair amount of cultural feeling out there that stock picking is something that experts do and that you should pay an expert to do. But over time this perception is fading, so that as of 2019 passively managed funds account for nearly half of all stock funds.

As for why portfolio managers exist and why companies pay them. . . Well, as long as the above is true, and people are willing to pay for this "service", then companies will try to make money by selling that service to people.