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Paper: Active Funds Benefit from Investor Perception of Managers’ Work Ethic

A paper from the University of Chicago Law School examines why investors continue to pick actively managed funds despite evidence of the “inferiority of most actively-managed funds.” The authors write that given active funds’ poor performance relative to passive strategies “it is difficult to explain how so many active managers who deliver unimpressive performance at high cost relative to other investment alternatives continue to attract and retain investors.” The authors hypothesize that investors are misled by the belief that good investment performance is more likely if the investment manager works hard. “[I]t may simply be too difficult for a substantial number of investors to believe that superior returns are available by doing nothing but investing in an index fund rather than investing with active managers.” They add that this belief rings especially true to investors when active managers advertise that they have certain specialized expertise, work harder, and have a talented workforce with the resources needed to achieve extraordinary results. The authors say this “conjunction fallacy” raises significant policy questions, including whether actively-managed equity products should carry warnings for investors.