Re: Beyond Active and Passive: The Customization of Finance
Dear CFA Institute,
Your recent monograph, Beyond Active and Passive Investing, is a well-crafted reflection on the changing landscape of asset management. It outlines the evolution from traditional active management to indexing, smart beta, and now, the rise of hyper-customized portfolios. The shift toward personalization is indeed an important development. However, the paper rests on a foundational assumption that deserves much closer scrutiny: that market-cap weighting remains the appropriate benchmark for evaluating performance.
This assumption, rooted in capital market theory, goes largely unchallenged. Market-cap weighting is presented as efficient and convenient, yet its real-world effects are rarely addressed. It systematically concentrates capital in the largest, most visible companies, creating a feedback loop that amplifies their dominance. What begins as an index eventually becomes a market-moving force. The result is not neutrality—it’s reinforcement of incumbency.
Why is this still the benchmark? Why is it still treated as a fair and objective yardstick, despite its obvious concentration, its winner’s bias, and the systemic risk it creates through sheer scale?
The paper also avoids a deeper discussion of alpha. If alpha has become harder to generate, is that due to manager inefficiency—or because performance is measured against a structurally biased index? This is a critical distinction. When active managers are benchmarked against a system designed to favor what is already large and successful, underperformance becomes inevitable—not because skill is lacking, but because the rules quietly tilt the playing field.
Theories like CAPM and its descendants provided valuable insights in their time. But the assumptions behind them—perfect information, frictionless markets, linearity—are increasingly misaligned with today’s dynamic, data-rich environment. These models are not irrelevant, but their continued dominance has created intellectual inertia. Their simplicity is elegant, but elegance should not come at the cost of realism.
The paper’s vision of personalized portfolios is forward-looking, but personalization built on flawed benchmarks risks becoming window dressing. If hyper-managed accounts simply track a benchmark that compounds bias, then the innovation is only in the packaging, not the substance.
So we must ask: should we accept that market-cap benchmarks are beyond question? Should we surrender to the idea that hyper-customization is the only future left for active management? Or should we offer active managers better tools—models that recognize feedback loops, probabilistic dynamics, and the structural biases at play?
The decline in active management isn’t just about cost or skill. It’s also about measurement. And if measurement is flawed, then the narrative around active performance is incomplete.
In an age of intelligent systems and complex analytics, we have the opportunity to rethink—not just how portfolios are delivered, but how they are constructed, evaluated, and understood. The CFA Institute is uniquely positioned to lead this conversation. That includes not just product innovation, but foundational reexamination.
Thank you for your continued leadership in the profession. I hope this letter contributes to a broader dialogue about where we go next—and how we ensure the models we follow still serve the markets we aim to understand.
Mukul Pal