Here is Dave Leonhardt’s stimulating piece. Here is the key fact:
Last year, the Standard & Poor’s 500-stock index jumped 14 percent, while the average hedge fund returned less than 13 percent, after investment fees, according to Hedge Fund Research in Chicago…Since 2000, the average hedge fund hasn’t done any better, after fees, than the market as a whole, according to research by David A. Hsieh, a finance professor at Duke.
My guess is that a small number of very bright individuals can in fact beat the market on a systematic basis. Today the world can mobilize enough capital so that these people become very very rich and have a larger impact on market prices than in times past. These individuals also spawn overconfident imitators, which lead to subnormal returns for the non-superstars. On average the gains and losses are a wash, but the true stars must limit the amount of capital they manage, for fear of pushing around market prices too much. Some set of insiders thus continue to gain wealth whereas most outsiders are playing the usual efficient markets game, with slightly subpar returns, due to the informed trading of the insiders. The geniuses are in effect taxing the uninformed trading of the non-genuises, but I do not see the trading volume of the latter group falling in response. In that model, in the first best, it is the trading of the losers — not the winners — which should be taxed.