The 'Fundamental Law of Active Management' Is No Law of Anything

Roughly half of all globally professionally managed funds employ optimized portfolio design principles that are applications of Grinold’s “Fundamental Law of Active Management.” These include: Invest in many securities, use many factors to forecast return, trade frequently, and optimize with minimal constraints. We show with simple examples followed by rigorous simulation proofs that these proposals are invalid and self-defeating. This is because estimation error and required economically valid constraints are ignored in derivations. These flawed principles have been unchallenged by academics and practitioners for more than twenty years and possibly adversely impact as much as a trillion dollars or more of managed assets in current investment practice.