May 17, 2004

The size effect and the relative performance between active and passive management are directly related. They are two sides of the same coin. The interaction between the weighting scheme of an index and size effects is a powerful insight for it tells an active manager when his portfolio should be "index-like" and when to pursue an active strategy with gusto. Taking advantage of the one-to-one correspondence between the size effect and market breadth (i.e. the odds of beating the benchmark by randomly selecting stocks), we can make inferences regarding the conditions under which active management prevails over passive management.

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