2. Are there managers who can exploit market inefficiencies? That is, are there managers with skill?
Markets can be inefficient but that does not mean that all active managers trying to exploit these inefficiencies have skill. There can still be only a small number who actually have the skill of being able to exploit inefficiencies. If the answer to the question is no, then there could be room for specific strategy benchmarks or smart beta alternatives that may be able to exploit some inefficiencies. The spectrum of strategies could include rules-based portfolio that exploits inefficiencies through benchmark at relatively low cost.
This is not easy because differentiating between those managers with and without skill may take a lot of data and there may be switching between skill managers based on the environment or the strategies that are successful. A manager could be a skilled at value investing but not able to make significant gains during a period when value is out of favor. If an investor does not have the ability to identifying the manager with skill, then he should move back to the passive diversified portfolio.
The conclusion is that any holding of active managers has to be based on the market environment, the quality of managers, and the ability of investors to identify an inefficient environment and skill managers. Since the markets are generally efficient, good managers are rare, and it is hard to find those managers, active management should be an exception not the norm.