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Excerpt

Opening Statement of Counsel for the Plaintiff

Ladies and gentlemen of the jury, we are here today for one reason: Mr. Smith, the defendant, has failed to act in the manner of a "prudent man" as defined by the law that Judge Knowles has just reviewed. And what is the nature of his failing? It is quite simple: Mr. Smith has invested all of the savings for which he is responsible into a portfolio of index funds. Now let me be clear: we are not claiming that this portfolio is not sufficiently diversified. No, the imprudence we are claiming lies in Mr. Smiths' failure to maximize the potential return on the assets for which he has a fiduciary responsibility, by virtue of his failure to place some or all of them into actively managed investments. We will shortly prove his imprudence to you by citing not only investment theory, but also the track records of some very famous investors like Warren Buffet, who, over long periods of time, have delivered returns substantially above those earned by Mr. Smith's index investments.

Opening Statement of Counsel for the Defendant

Good morning ladies and gentlemen. I don't know about you, but I sure am looking forward to hearing the plaintiff's case. Frankly, I'm just a little bit curious about how they plan to logically reach the conclusion they just asserted given the theoretical and factual arguments that are available for them to use. If nothing else, I guarantee you this won't be a boring jury to sit on. And you know what? Because I'm just as anxious to hear their side of the story as you are, I'm going to keep these opening remarks very brief. All I'll say at this point is that after you hear our arguments, you'll probably end up wanting my client, Mr. Smith, to manage your investments. We're going to show you how the plaintiffs' case fails, not just on theoretical and practical grounds, but also as a matter of law. As they say in the great game of baseball, three strikes and you're out. So, for now I'll just say "batter up!", and turn things over to the plaintiffs' counsel.

Indexing Versus Active Management: The Trial of a Prudent Investor

Table of Contents

Preface

The Judge's Introduction

Opening Statement of Counsel for the Plaintiff

Opening Statement of Counsel for the Defendant

The Plaintiff's Case in Favor of Active Management

Alpha Versus Beta
The Information Ratio
Forecasting Skill
Investment Strategy Breadth
Historical Returns Evidence

The Defense Case in Favor of Indexing

Its Hard for a Company to Deliver Consistently Superior Returns
Theory Says Active Management Success is Rare
Active Funds' Sales, Operating, Trading and Tax Costs
Forecasting Skill is Hard to Sustain
It is Impossible to Identify Superior Active Managers In Advance

Plaintiff’s Rebuttal
Defense Rebuttal

If Not Past Performance, Then What?
Could All Those Active Investors Be Wrong?
Everybody Can't Index

Plaintiff’s Closing Argument
Defense Closing Argument
Judge Knowles' Instructions to the Jury

About the Authors

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