Presented by Greg Stalsberg, CFA, CAIA Director of Capital Markets Research at Slocum and Scott Tonneson, CFA Vice President, Senior Research Analyst and Co-Portfolio Manager at Nuveen
A filled room heard from two industry experts on how the use of active management (vs. passive), in their opinion, is not a simple all or nothing decision. There are critical factors that go into the use of active (and passive) investment strategies that revolve around an in depth knowledge of the client, strategic vs. tactical asset allocation and the current market environment.
From Greg’s perspective as a consultant, there are certain asset classes/spaces that tend to be more efficient, and therefore difficult for a meaningful percent of active managers to consistently outperform. US large cap stock, for example, is a space that was noted as being relatively efficient. The excess return of the outperforming funds tends to be modest and perhaps not enough to compensate the investor for the periods of underperformance. This is a space where using passive investments and just capturing the low cost beta could be appropriate. Greg did mention that there are good US large cap active strategies, however you need to invest the time and resources into proper due diligence. The story is different for US small cap and international stocks. Research has shown that a greater percentage of active managers have been able to outperform in these spaces. Furthermore, the outperformance of the active (US small cap and international) strategies has been more substantial.
As the title of the event alluded to (“A Defense of…” not “The Defense of…”), it really is not possible to defend all active management with a single point. This is because there are numerous types of active management styles. So how does one sort through the universe of active investment strategies? Scott mentioned a few metrics to review when analyzing active strategies. First was active share. Academic studies have shown that funds with higher active share have in general been able to add more value. Secondly, it is also important to know if a portfolio manager invests personal money in the fund they manage. A manager that has “skin in the game” is important for alignment of interests. Lastly, the investment process should be transparent.
Scott noted the importance of patience with investment selection as it can take time for an investment thesis to pan out. Over the last several years, low market dispersion, Fed stimulus, and cash drag have weighed down the performance of some stock pickers. An active manager may underperform for a few quarters before periods of outperformance. Short term performance comparisons, although relevant, should not play a large role in decision making. Markets go through cycles and mean reversion is a powerful force. Some research has shown a strong correlation between active manager outperformance and rising interest rates, which could mean more active managers outperform in the coming quarters.
In a world with countless investment strategies, non-stop media outlets, and never ending distractions, both Greg and Scott agree that remaining focused and following your investment policy is important to avoid making the wrong decision at the wrong time.