Manager Selection

Even if securities markets are inefficient, the market for investing in active managers could be. Managers could either manage more assets until their excess returns declined or charge higher fees so that no excess returns are left for investors. It is difficult or impossible to short actively managed funds and, under these conditions, the Miller impediment-to-short-selling theory predicts some overvaluation of active management. That is, optimistic investors might pay excessive fees to popular managers.

This does not rule out good managers at fair prices. Some managers will value having certain investors as clients. One thing is certain: Bad managers exist as do some outright frauds. Avoiding frauds is the easy part. Identifying operational risk to performance requires more expertise. Identifying bad managers seems, to me, to be a reasonable strategy.