An inventory fund used in conjunction with a single actively managed portfolio will filter out the beneficial impact of all potentially valuable active trades with workout times shorter than the fund’s periodic rebalancing period. On the other hand, valuable trades with workout times long enough to contribute to performance will incur transaction costs. Thus an active portfolio alone will provide better performance if the manager is competent.

When there are multiple active portfolio managers, purchases and sales of the same security will never occur at precisely the same time. If there is genuine value in the active portfolio managers’ trading, the filtering effect of the index fund will prevent the combined assets from benefiting from trades that offset within the rebalancing period. On the other hand, the inventory fund will provide a savings in transaction costs.

If there is genuine value in the managers’ trades, however, the proportion of offsetting trades will be small and the opportunity loss will outweigh the savings in transaction costs. If there is little value in the active managers’ trades, the proportion of truly offsetting trades will be large, and the savings in transaction costs will outweigh the opportunity loss.

When active managers’ trades are genuinely valuable, a better approach is to treat them as sources of estimates, not transactions, combining the estimates of several managers to obtain a single summary estimate and, in effect, creating a single “super manager.” As already noted, however, when there is only one competent manager an inventory fund will always be inferior to an independent active portfolio.