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Cost of active investing a “tax” on the market

The cost of active management should be seen as a tax investors pay for the benefit of a healthy market, according to an occasional paper published by the FCA.

Though published by the regulator, the paper does not reflect the official view of the FCA.

The research note looks at the effect of the growth of passive investing on equity market.

It says active management creates a balanced equity market that works well and simultaneously boosts the value of public listed companies. Whereas too much of a shift toward passive would lead to a detrimental effect on the quality of the market, overall economic performance and investor detriment.

The researchers acknowledge this is the risk despite the fact that on a case by case basis it may be sensible for individual investors to opt for the more cost-effective passive route.

The paper states the extra cost of active investing could therefore be seen as a tax contributing to sustaining the quality of the market:

“One can therefore think of the cost of active management as a tax that investors who (directly or indirectly) invest through or trade with actively managed funds pay collectively to bring the public good of an efficient and effective equity market good about. This efficient and effective market tax is significant.”

Data from the US included in the research shows the total cost of equity active management is equal to about 0.7% of market capitalisation.

Shining a light on corporate governance issues is one of the ways active investing contributes to a quality equity market, the research adds.

“While both active and passive funds participate in routine engagement, active and passive funds may differ in both their incentive and their ability to engage with firm management more deeply. Routine engagement can lead to substantial increases in firm value.”

The task for the FCA, states the paper, is to design a regulatory regime which enables a healthy equity market while minimising the cost of sustaining that market.

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Comments

There are 3 comments at the moment, we would love to hear your opinion too.

  1. Oh my goodness, what nonsense!

  2. Good grief I have been saying similar for years. Without active there wouldn’t be any passives. Passive takes a free ride and if everyone went passive there wouldn’t be a market at all.

    Anyway who wants passive in a falling market?

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