Financial Times – Actively managed funds are on a roll

June 2015

For registered investment advisers with an active management bias, the past decade has been tough. As low interest rates and a Federal Reserve stimulus buoyed equity markets, cost-efficient passive funds thrived, raising doubts about pricier active strategies.
Only 45 per cent of active portfolios beat their benchmark during the 10 years up to January 1 2014, with a majority of those outperformers failing to generate a return greater than 1 per cent, according to financial magazine Barron’s analysis of stockpicking funds that month. The last year active large-cap stock managers outperformed their benchmark was 2009, data provider Lipper says.
But recent Morningstar research suggests the tide may be turning in favour of active investors and RIAs who kept faith are expecting a resurgence. To highlight opportunities, they are publishing economic outlooks explaining why active investing is the most effective way to generate returns and hedge risk today.
“Active management is alive,” says Elliott Elbaz, founder of Gordian Wealth Advisors. Indeed, Mr Elbaz’s latest outlook emphasises three themes active investors should exploit: a stronger dollar, weaker oil prices and low interest rates. “We looked for active managers in regions abroad that would benefit most from a more muscular greenback,” Mr Elbaz says. “The best opportunities have been managers with exposure to Europe, Asia and India.”
RIA company executives agree that active managers are poised to benefit from the widening performance spreads between the different asset classes. “Markets are rewarding companies that are performing well earnings wise . . . And they are punishing companies that are not performing,” says Kevin Guth, partner and managing director at Snowden Lane Partners, an FT 300 company that oversees $1.7bn in assets. “Markets were largely correlated after the financial crisis, but that has changed.”
Morningstar data show actively managed US equity funds have outperformed their benchmarks during the first four months of 2015. Such strategies returned 2.25 per cent compared with 1.9 per cent and 2.20 per cent for the S&P 500 and index funds, respectively.
In a sign of confidence, large active equity managers are stepping up their advertising. For example, Fidelity Investments launched a “power of active management” advertising campaign this year touting two veteran portfolio managers.
Active-oriented RIAs contend that retail investors will have no choice but to break the long trend of favouring passive funds over active funds, especially given pending market volatility. Net flow assets to passive-oriented exchange traded funds and index funds stood at $239.88bn and $182.7bn, respectively, in 2014, Morningstar data show. Yet active funds attracted only $43.3bn during that period.
“Active management will absolutely make a comeback,” says RIA Don Garman, founder of Mirador Capital Partners, which oversees $300m in assets. “If you think about the math, when passive management becomes so widely adopted that people are blindly buying more of the highest market cap securities, active management will once again matter.”
To warn of a passive-fuelled equities bubble, Wintergreen Advisers published an outlook last month saying the rush into index funds has caused market capitalisations of mega-cap companies to balloon while smaller, strong-performing companies were overlooked.
The trend has caused risky capital misallocations that will harm investors, the report said.
Meanwhile, RIAs who base their active strategy too closely on their future macroeconomic outlook may be making a mistake, warns Scott MacKillop, former president of Frontier Asset Management.
“On close examination, I would expect that RIAs who based their investment processes on their ability to make accurate economic forecasts probably have pretty unimpressive track records,” he says. “There are few instances of asset managers who produce consistently good results for their clients by trying to invest based on their economic forecasts.”
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