The Deadweight Loss of Active Management

We evaluate the performance of US active equity funds based on their Sharpe ratios. Only 13% of funds outperform the market index after fees. We estimate the aggregate annual loss to investors in US active equity funds at $235 billion. This loss can be decomposed into an inefficient portfolio allocation component of $186 billion, and a fees component of $49 billion. The loss estimate based on Sharpe ratios is about 10 times larger than estimates based on alphas, and we argue that Sharpe ratios are more relevant from the perspective of most investors. We discuss possible explanations for the persistence of this large inefficiency and suggest ways to mitigate it.