The Evolution of Active Management: From Stock Picking to Active Asset Allocation

by Simon Nocera, 4/21/25

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Introduction

The debate between active and passive money management has been ongoing for decades, with passive investing gaining increasing support due to its superior long-term performance relative to traditional active stock picking. Data over the past two decades — likely even longer when adjusting for survivorship bias — has consistently shown that approximately 95% of active managers (of all domestic U.S. funds) underperform their benchmarks. The sheer scale of inefficiency is striking: In 2020 alone, American investors paid an estimated $190 billion in fees to active managers, largely subsidizing a system that fails to deliver (95% of the time!) consistent excess returns.

One questionable reaction to this persistent underperformance has been to push investors into alternative funds, such as hedge funds and private equity. However, these so-called "alternatives" and “active vehicles by excellence” have failed to deliver meaningful performance and remain outrageously expensive.¹

The surviving argument for their inclusion in portfolios is that they offer diversification benefits, particularly during market downturns. Yet empirical data suggests otherwise. Rather than paying exorbitant fees for questionable diversification benefits, investors would be better off achieving true diversification through, for example, exchange-traded funds (ETFs), at a fraction of the cost.

Indeed, framing the discussion as a binary choice between active and passive investing is misleading and futile. Active management has not disappeared — it has simply evolved. Rather than focusing on outdated stock selection methodologies, today’s most effective active strategies center on active portfolio construction and dynamic asset allocation. This shift is not just theoretical. It is being driven by the profound structural changes in global financial markets, particularly the rise of ETFs — over 11,000 globally, and growing (which is more than twice as many as U.S.-listed stocks; see Chart 1), or more than twice as many U.S.-listed stocks, covering every granular segment of the global financial markets and satisfying any mandates, styles, strategies, tactical moves, etc.

Why stock picking no longer works

Stock picking as an investment strategy has become largely obsolete for the vast majority of investors attempting to outperform a specific benchmark. The reason is simple: In today’s digital world, information flows instantly, markets adjust rapidly, and inefficiencies are arbitraged away before they can be exploited. The key drivers of this phenomenon include:

1. Instant information dissemination: With near-zero marginal cost communication, financial data, earnings reports, geopolitical events, and economic indicators are transmitted globally in real time. The days when a skilled investor could exploit information asymmetry, e.g., days of market inefficiency, are long gone.

2. Massive computational power & scalability: A retail investor today has more analytical tools on their smartphone than hedge fund managers had in the 1980s. Algorithmic trading firms process millions of data points per second, continuously refining pricing models and removing opportunities for easy alpha.

3. Global market efficiency: With thousands of (sophisticated) market participants, including institutional investors, quants, and AI-driven trading platforms, any significant mispricing is detected and corrected almost immediately. This makes it nearly impossible for an individual or even a team of stock pickers to consistently outperform the market over time, i.e., the efficient market hypothesis is well in evidence with the 95% quote above.

4. The death of asymmetric edge: In the past, fundamental analysis could uncover mispriced stocks before they became widely recognized. Today with widespread access to machine learning, satellite data, alternative datasets, and real-time market feeds, those small edges have vanished. Even professional money managers with extensive resources struggle to “keep up” with a simple index fund.

This fundamental transformation renders traditional active stock-picking funds not only ineffective but also economically indefensible given their high fees. Indeed, active mutual funds are consolidating and/or disappearing following a true Darwinian process.

The new frontier: Active asset allocation & portfolio construction

The explosion of ETFs has fundamentally transformed how investors are able to implement views, express valuation differentials, and make tactical moves. These instruments cover every conceivable segment of the financial markets, spanning geographies, sectors, factors, risk premia, commodities, fixed income, styles, alternatives, and thematic investments. The key advantages of ETFs in modern portfolio construction include:

1. Granularity & precision: Investors can now target highly specific exposures, from country-level indexes to niche industries, styles, and even single factors like momentum or low volatility. This enables precise implementation of macroeconomic, sectoral, or thematic views, thus materially increasing the probability of successful investment outcomes.

2. Cost efficiency: Traditional active funds charge exorbitant fees — often exceeding 1% annually — while delivering subpar results. In contrast, ETFs provide exposure at a fraction of the cost, with expense ratios averaging around 25 basis points (0.25%), and often much lower. This dramatically reduces the drag on returns.

3. Liquidity & flexibility: Unlike mutual funds or “closed/illiquid” alternative funds, ETFs trade intraday, allowing for real-time tactical adjustments. This is crucial in volatile or rapidly changing markets, where strategic reallocation can preserve capital or capture emerging opportunities.

4. Systematic implementation of active views: Instead of attempting to identify individual stocks, investors can now express their macro or valuation-based views through sector rotations, factor tilts, duration shifts, credit risk adjustments, or thematic plays — all executed through low-cost ETFs.

The future: Active management as portfolio engineering

Investors who once sought alpha through stock picking should shift their focus toward constructing efficient, risk-adjusted, and dynamically managed portfolios taking advantage of infinite global and granular investment opportunities. This represents a more scalable and adaptable — as well as the most economically viable — form of active management. The successful investors today are not those picking stocks but those who:

Adjust exposure dynamically based on valuation signals, economic data, and market conditions.
Implement factor-based and thematic overlays — e.g., growth, value, quality, etc. — to enhance returns and mitigate risk.
Use low-cost vehicles to express views with maximum efficiency, such as ETFs.

This paradigm shift is not a rejection of active investing in favor of passive — it is a recognition that the nature of active management has changed. The question is no longer whether active or passive is superior; it is how to be active in a way that aligns with the realities of modern financial markets.

Conclusion

The rise of ETFs and systematic allocation strategies has fundamentally altered the investment landscape. Active management has not disappeared — it has migrated from stock picking to active asset allocation and portfolio construction. The sheer breadth of ETF options now allows investors to implement an almost infinite array of strategies at a fraction of the traditional cost.In a world in which fees and inefficiencies matter more than ever, active investors must evolve or risk irrelevance. True active management today is not about picking stocks — it is about constructing the right portfolio with the right exposures, at the right time, using the right tools.

Simon E. Nocera is the founder and managing partner of Lumen Global Investments | Lumen R4A, a digital investment solution for global asset allocation and portfolio construction.

^1. According to a study by LCH Investments published in the Financial Times on January 19, 2025, hedges funds have been pocketing about 50 percent of return since the 1970s. Hedge fund managers pocket almost half of investment gains as fees. The industry has taken $1.8 trillion in charges since the 1960s, according to the article.

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