The Life Cycle of Investment Management When 'Today's Alpha is Tomorrow's Beta'

I present a model where competition in the asset management industry has positive and negative effects on fund performance. When funds have increasing (decreasing) returns to scale at the industry level, the flow-performance relation is concave (convex). Active funds outperform their benchmark initially. Competition among funds raises the cost of active management and gradually depletes the profitable opportunities in the aggregate. Eventually, the total surplus declines to zero and the average active manager falls behind the benchmark. Aggregate risk is reduced over time through "closet indexing", until all active funds form a scalable pool of passively invested capital.