Part 6/11:
Renowned economist Bill Sharpe's arithmetic of active management posits that aggregate investors in active funds underperform those investing in index funds due to higher costs. However, a crucial consideration in Sharpe's model is that it presumes passive managers do not trade during the measurement period. In reality, index funds must adjust their holdings due to the dynamic nature of stock markets, thus, occasionally engaging in trading that may expose them to adverse selection and price impact.