Active Management Required

FT-active-managerWe have all heard the arguments about the flaws of active management and we all should have looked closely at the underlying data. Over any random 12-month period, about 60 percent of mutual fund managers underperform. Lengthen the time period examined to 10 years and the proportion of managers who underperform rises to about 70 percent. Even worse, equity managers who underperform do so by roughly twice as much as the outperforming funds beat their chosen benchmarks and the success of the outperformers doesn’t tend to persist. The SPIVA Scorecard from S&P demonstrates this phenomenon regularly and routinely.

Institutional investors fare no better. On a risk-adjusted basis, 24 percent of funds fall significantly short of their chosen market benchmarks and have negative alpha, 75 percent of funds roughly match the market and have zero alpha, and well under 1 percent achieve superior results after costs—a number not significantly different from zero in a statistical sense. Pension fundshedge funds, endowments and private equity funds all provide similar outcomes in slightly different settings.

Meanwhile, and not surprisingly, assets are following performance. Just a decade or so ago, passive investing was a relatively small slice of the investment universe. On November 1, 2003, just 12 percent of all U.S. open-end mutual fund and ETF assets (not including fund-of-fund or money-market assets) were invested in passively managed products, according to Morningstar. Today that percentage stands at 27 percent and is growing fast. In the equity markets, fully 35 percent of all investments are now held in passive vehicles.

The obvious conclusion from all this data is that active management has lost. Sure, most money is still placed with active managers (at least for now), the story goes, but active management is like Nazi Germany after D-Day. The war wasn’t won (yet) and a lot of work remained to be done, but the outcome was inevitable. That narrative is prevalent throughout the investment world.

However, and to the contrary, I think active management is an absolute necessity. Continue reading

Voting with their Feet and their Dollars

I have regularly challenged advisors to justify their use of active management. 

It seems to me that anyone in the active management business ought to be able to defend the process of active management with more than a sales pitch — y’know, with data and stuff.

Examples of my challenges and related posts are listed below.

Sadly, the challenge remains largely unmet by the investment world as a whole. However, since I favor active management for a variety of investment types and styles, The Value Project — linked above — provides my response to this challenge.

It is therefore probably not coincidental that one of every three dollars invested in mutual funds and exchange-traded funds through the first four months of the 2012 has gone to Vanguard, according to Morningstar Inc. (and as reported by Investment News).  Investment in Vanguard so far this year is roughly $65 billion, nearly four times more than the next closest mutual fund company – PIMCO.  In ETFs, year-to-date through the end of April, Vanguard had gathered $21.6 billion, while BlackRock’s iShares collected $13.3 billion and State Street added $7.2 billion. As always, Vanguard focuses on passively managed index funds and ETFs. 

It seems clear to me that many advisors are simply not meeting the challenge to active management offered by the likes of Vanguard and, as a consequence, consumers are voting with their feet (and their investment dollars).  Moreover, low fees matter, especially in a low return, low yield world.

Consumers have pretty clearly thrown down the gauntlet.  How will the active management business respond?  Will it respond?

Here’s hoping, but only time will tell.