Acting Alpha
Fund managers and analysts stay in power not just by generating returns, but by crafting stories that justify their role.
Most of what is taught at business schools about the role of financial markets and their actors—and later preached by professionals—is that investment decisions are based on hard data, rigorous analysis, and rational decision-making. However, those of us who have spent years working in financial markets and have been up close to investment decisions and analysis have seen plenty of practices that contradict the overarching theories of market efficiency and the rational economic actor. If the efficient market hypothesis were true—that all information is already embedded in prices and that no one can consistently outperform the market—then there would be no rationale for active fund management or any form of price discovery analysis.
Beneath the spreadsheets and balance sheets, when we apply a different perspective, what can the market’s actors tell us, or better yet, show us?
I recently read two prominent academic articles within the field of the sociology of finance:
Competing for Narrative Authority in Capital Markets: Activist Short Sellers vs. Financial Analysts (Stolowy, Paugam, and Gendron, 2022)
Active Fund Managers and the Rise of Passive Investing: Epistemic Opportunism in Financial Markets (Millo, Crawford, and Valentine, 2023)
Activist Short Sellers vs. Financial Analysts
The first article examines the competition between activist short sellers and financial analysts over which actor is the most credible interpreter of a firm’s financial future. Activist short sellers challenge analysts by portraying them as lacking market expertise and critical thinking. Both groups engage in "framing" (a concept from framing theory in sociology), using rhetorical strategies to reinforce their expertise while undermining the other’s credibility. Analysts largely ignore short sellers’ critiques and are reluctant to engage in public disputes. However, in some cases, analysts quietly adjust their target prices downward while maintaining buy or hold recommendations, illustrating the fragility of their narrative authority.
This study highlights the performative nature of financial expertise—that financial knowledge is not just about possessing analytical skills but also about demonstrating, maintaining, and being recognized for that expertise. The "winning" narrative shapes market actors’ behavior, meaning financial professionals do not just predict the market—they help create it. In this sense, the financial market is an arena of narrative contestation.
Active Fund Managers vs. Passive Investing
The second article describes the current challenges facing active fund managers, as passive funds have outperformed, outgrown, and become far cheaper. The quest to generate ‘alpha’ is being beaten by the simple strategy of tracking ‘beta’. For example, only 23% of active funds outperformed their passive counterparts between 2010 and 2020. This shift has led to the dominance of passive giants like Vanguard, State Street, and BlackRock, which now collectively own about 20% of the S&P 500, primarily through index-tracking funds.
The study explores how active fund managers react to this changing asset management landscape, where fees are being driven to the bottom and their very existence is being questioned. The authors apply the concept of communities of practice, which refers to active fund managers forming a distinct professional community that upholds specific norms, beliefs, and ways of knowing—even when faced with mounting evidence that passive investing outperforms active strategies. One example of this worldview, as highlighted in the study, is that active fund managers are built around the possibility of ‘generating alpha’ or the mantra of ‘beating the market’.
A particularly interesting finding is that active fund managers both believe and do not believe that they can beat the market and both believe and do not believe in the efficient market hypothesis. This contradiction creates cognitive dissonance—a mental discomfort that arises when one’s beliefs and reality conflict.
As their core belief system is challenged by the rise of passive funds, active managers engage in epistemic opportunism—strategically reinforcing narratives that justify their continued existence despite mounting evidence to the contrary. They do this by:
Asserting a strong professional identity
Delegitimizing passive fund management, arguing that active management is essential for price discovery
Engaging in “hopeful fantasizing”, anticipating a bear market that would validate their expertise
Framing certain practices as inaccessible to passive fund management, such as ESG investing
These tactics are used to protect the status quo. Rather than adapting to the growing competition from passive investing, active fund managers are clinging to their existing position of authority.
The Bigger Picture: Narrative Battles in Financial Markets
Both studies reveal how financial professionals—whether fund managers defending active investing or analysts resisting short sellers' critiques—engage in narrative battles and epistemic opportunism to sustain their authority. This highlights that expertise in financial markets is as much about performing and defending credibility as it is about generating returns.
Capital markets are not just about numbers but also about competing stories, battling for narrative authority. Understanding this dynamic is essential to grasp how financial markets truly operate beyond the textbooks.
