Abstract
This study examines the pattern of active versus passive trading in UK equities over the period 1991-2005. We describe a metric to analyse trading activity and volumes in the UK FTSE350 and AIM markets, with emphasis on industrial and size-based effects. Our findings indicate that active stock picking has been consistently declining in the UK market over the period studied for all markets, size quintiles and in virtually every industrial sector. Moreover, trading patterns reveal a pronounced size effect with significantly less stock picking in larger capitalisation stocks vis-à-vis smaller stocks. Patterns of investment in the AIM suggest an increase in index trading over time but higher overall levels of stock picking relative to the FTSE350 list.
Highlights
Theories of efficient markets, standard paradigms of academic and empirical finance, have clear implications for asset combination and diversification decisions
Our findings indicate that active stock picking has been consistently declining in the UK market over the period studied for all markets, size quintiles and in virtually every industrial sector, which evidence is consistent with patterns of trading documented for the US and some other markets
Patterns of investment in the Alternative Investment Market (AIM) suggest and increase in index trading over time but higher overall levels of stock picking relative to the FTSE350 list
Summary
Theories of efficient markets, standard paradigms of academic and empirical finance, have clear implications for asset combination and diversification decisions. Rather than incur the significant private costs of research to obtain proprietary information, investors should be as well off investing (passively) in a market index which includes a broad range of different securities. With this approach, the volume of trade in any particular stock should reflect the weight of that firm in the market portfolio/index, and market weighting should explain fully the variation in volume of trade. This leads to an upsurge in the use of skill and research on the part of professional investors to identify mispriced securities and trade on that mispricing, a process which is costly and which offers no guarantee that benefits will outweigh the very substantial costs of information acquisition and trading. Carhart (1997) among others documents the magnitude of active vis-à-vis passive trading costs and notes that, in terms of net returns, actively managed investment funds have tended to under-perform their passively managed counterparts. If the benefits of active fund management consistently fail to outweigh the costs passive investment is surely more constructive for investors
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