Volatility returned suddenly to US equity markets this year, offering true active managers the chance to demonstrate their value.
The reduction in correlations between shares and wider dispersion of returns within the benchmark can create more opportunities for skilled stock-pickers. The volatile environment also enables more active risk management in portfolios, and gives more opportunities because of pricing anomalies.
According to the Natixis Investment Managers Global Survey of Institutional Investors 2018, 76%1 of institutional investors agreed that the market favoured active management this year. They said active managers are best suited to generating risk-adjusted returns and stable income; exploiting short-term market movements; adding downside protection; and providing access to non-correlated assets. All of these are particularly helpful in a volatile environment.
Higher allocations to active managers in 2017 paid off for investors, according to Natixis Portfolio Clarity analysis of moderate portfolios. Top-quartile performing portfolios had high exposure to active managers. Meanwhile, the cost of active management is coming down - average portfolio expenses fell to 67 bps in 20172, from 84 bps in 2013.
High active share
True active strategies – ones with high active share – outperformed the S&P 500, and out-earned their fees last year and over the long term, according to the Natixis analysis.
Active share measures how different portfolio holdings are to those of the appropriate passive index. A high active share is usually over 80%.
Proponents of passive investing cite inconsistent performance of active funds, but tend not to differentiate between those that have a high active share and those that do not.
Professors Martijn Cremers and Antti Petajisto have demonstrated the effectiveness of active share since they introduced the concept in 2009. They said funds with an active share of 60% or less tend to generate very similar returns to the index, but may charge a higher fee relative to an index fund. These types of funds are sometimes referred to as ‘closet trackers’.
Cremers’ work shows that managers with active shares of at least 90% and patient investors (those with fund duration of more than 24 months) have outperformed their benchmarks by 2.22% a year, on average. Also, these managers outperformed their benchmarks by 80% in the 27 years to 2012.
Related studies have also identified active manager conviction and skill as potentially relevant factors in outperformance.
eVestment has studied this area as well and proposed new measures that build on the concept of active share. These are active share efficiency, which evaluates excess return relative to active share; and peer share efficiency, which calculates according to a peer group’s universe of holdings, rather than standard benchmarks.
Martin Cawley, CEO at London-based Devonshire Wealth Management, said: ‘Passive managers provide important access to the US sector. But the huge increase in computer driven trading in this space means that active management can take advantage of any market anomalies it creates. February’s market falls exemplified this effect.
‘We measure whether an active fund is adding value by analysing factors such as volatility, alpha, Sharpe ratios. Active share is also a valuable metric.’
The predominance of technology companies in US indices is a current concern, added Cawley. Another benefit of active management is that it can identify smaller companies with potential, he said.
Mohsin Bukhari, head of investment research at London-based Carrington Investments, said the comprehensive coverage of large cap US equities affords little scope for informational advantage, making active management difficult.
‘Despite this, active US managers merit a place in portfolios and can add value,’ he said. ‘In large caps, they must be highly concentrated and evidence conviction in stock selection. More attractive is a multi-cap fund that can invest across the cap spectrum. Smaller US businesses tend to be less covered by analysts or not at all, presenting huge alpha generating opportunities.’
Alpha generation and smaller drawdowns are two important ways to measure an active manager's stock-picking skill, said Bukhari.
‘We also look at Sharpe ratios, which help assess the manager's alpha relative to the fund’s volatility,’ said Buhkhari. ‘Active share has become a popular measure, with many funds now reporting this figure. It is important to show you are getting what you’re paying for.
‘But high active share does not necessarily [guarantee] a winning fund - the active bets may be wrong. Therefore, looking at active share together with ratios such as alpha and Sharpe is more prudent.’
FOR INVESTMENT PROFESSIONALS ONLY. This material is provided for informational purposes only and should not be construed as investment advice. The views and opinions expressed may change based on market and other conditions. There can be no assurance that developments will transpire as forecast, and actual results may vary.
Provided by Natixis Investment Managers UK Limited, authorised and regulated by the Financial Conduct Authority (register no. 190258). Registered Office: Natixis Investment Managers UK Limited, One Carter Lane, London, EC4V 5ER.
This article was provided by Natixis Investment Managers and does not necessarily reflect the views of Citywire