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People passively invest because active investing rarely outperforms passive.Active rarely outperforms… after fees:
> […] We're a hundred students into class, 99 people make a left shoe, one person makes a right shoe. One of the students in the class made a right shoe." And then I say, "A pair of shoes goes for $100." I also made a left shoe. And so I approached the only person with the right shoe and they said, "Karl Marx said that how much time you spent making something determines its value. We both spent the whole day making it. I propose that we both get 50 bucks and then we sell the one pair of shoes."
> And then regardless of who the student is or what their political beliefs are, by the way, they always turn down that offer. They immediately say, "No way, you're not getting $50 for this." And I say, "Well, explain to me why you feel that that's the case." And then they say, "Well, I have all negotiation power because they're 98 other people in the class that I could go to for a left shoe. I have the thing in short supply, you have the thing in large supply. So who gets all the rents?" Then I say, "Well, how much do you think the person with the right shoe gets?" And invariably the class comes to the conclusion that it's somewhere between 99 and a hundred dollars, so that almost everything goes to the person who has the one right shoe.
> And so after saying that, I say to them, "Well, to do investment management, I need two inputs. Instead of the left and the right shoe. I need investible money and I need mutual fund managers skill. Now tell me which one of the two is in short supply." And so very quickly they come to the conclusion that having investible money makes you in no way special, because everybody has investible money. And so it's very difficult to call that a skill in short supply. The skill of the manager is something that is in short supply. Who is going to go home with the rents from this process? Just like the right shoe owner, they go home with everything, the manager goes home with everything. And so the value added is entirely absorbed by the manager in terms of fees. Which by the way is exactly the same reason for why the net alpha is zero. Because in this left and right shoe example, the net alpha is the amount of money the left shoe owner goes home with.
* https://rationalreminder.ca/podcast/220