He also thinks too many bastards can be destructive. “They can wear down the person bringing the proposal, despite not having done much research themselves,” King says. Gray says if you challenge too much (and you can always challenge these things), it can undermine people. “If you undermine their core investment values you find people lose confidence and the last thing you want is a manager who doesn’t have confidence.” Do we need optimism? According to the Marriott School’s Steven Thorley, the aggregate of managers believing that they have more talent than is statistically possible is a necessary evil for a functioning market. In his book The Inefficient Market Argument for Passive Investing, he writes that if every manager was free from optimism bias and could objectively rate their skills against those of other managers, two-thirds would realise that they would be better off indexing.

If they were to leave active management, the skill-pool might improve, but that would only make exploiting inefficiencies more difficult. He uses the analogy of a basketball free throw game to illustrate his logic: If you were in the basketball free throw game, and were given the alternative to sit out and take the average score of the other players, what would you do? Your first thought might be to look around and make a guess at how your basketball skills compare to everyone else’s. If you think your skills are lower than average (and remember, that must be half of everyone) then the smart thing to do is to not play: to take the average. But what if everyone else takes this approach? Then only those in the top-half of the skill pool will choose to play, and the average score you get by sitting on the sidelines will be based on only the top-half players. From this more rational perspective, you should only choose to play if your skills are in the top quartile of all potential players.

But what if everyone takes this more rational perspective? Eventually no one but the very best player shoots, and everyone else gets his or her score. If everyone were perfectly rational, and not subject to overconfidence, there would be very few active investors. Thus overconfidence, perhaps the most pervasive of all investor irrationalities, is critical to market liquidity. “If active investing is a skill-based game, then the skilled players will be worse off when lower skilled investors choose not to play,” Thornley says. “As an active investor, your ability to outperform the indexing alternative (be better than average) depends on the participation of players with below average skills. Someone has to sell the stock you want to buy at a bargain, and buy the stock you want to unload at a higher than justified price. Someone has to be wrong in order for you to be right. If equity investing is a skill-based game, then active investors should be encouraged by the entry of new investors, particularly novices.”