Column: Your active manager: better, cheaper, less successful - James Saft
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By James Saft
(Reuters) - Every year your active fund manager gets smarter, better trained and cheaper and every year she has a tougher and tougher time beating the market.
It isn’t so much that alpha is dying but that the suckers are all leaving the table. As more money flows into passive strategies the sum of gains to be had at the expense of dumb money diminishes, making alpha, or outperformance, harder and harder to achieve.
As many poker players have learned, but some never do, the fewer weak players at a table the more difficult it becomes to win something from the sharks who remain.
A look at the performance of hedge and mutual fund performance shows that underperformance is a long-term trend following what may be a steepening slope.
Over the 10 years to 2016, 82 percent of all U.S. large-cap managers, 87 percent of mid-cap managers and 88 percent of small-cap managers trailed their benchmarks, according to Standards & Poor’s Spiva analysis.
Morningstar’s Active/Passive Barometer, which weeds out funds which did not survive, also paints a dire picture of the health and prowess of the industry. Over 10 years only 17 percent of large-cap growth funds managed to successfully beat the passive alternative. Only one of 22 Morningstar active categories - U.S. Mid-Growth - managed to record a success, or outperformance, rate above 50 percent.
As for hedge funds, they too are failing, in aggregate, to create value. Hedge funds in the HFRI Fund Weighted Composite Index are down 0.18 percent over the past 12 months and have only logged 2.68 percent in annualized returns over the past five years, a period during which the S&P 500 has more than doubled in total return terms.
Of the more than 60 HFRI indices, not a single one has managed to provide even half the total return of the S&P 500 over the same period.
Many will argue, rightly, that the past decade has been unusual, partly because of the bubble and then because central bank intervention have indiscriminately raised valuations of a host of financial assets. That’s true, but cold comfort to people who could have done better by paying less, and often done so while taking considerably less risk.
ALPHA IS A ZERO-SUM GAME
Michael Mauboussin of Credit Suisse noted this month in a piece for clients he wrote on his 30th anniversary in investment that the percentage of assets managed passively has risen in that time from less than one to about 35 percent.
His argument, that of the poker table, is that relative skill matters rather than absolute skill in investment management.
“The difference between the best and the average is less today than it was a generation or two ago. We see this clearly when we examine the standard deviation of excess returns for mutual funds, which has declined steadily for a half century,” Mauboussin wrote.
“The massive shift in asset allocation away from active investing toward passive investing exacerbates this effect. Think of it this way: For you to have positive alpha, the industry’s term for risk-adjusted excess return, someone has to have negative alpha of the same amount. By definition, alpha for the market must equal zero (before fees). The truth is that weak players, whom the strong players require to generate excess returns, are fleeing at a record pace.”
The clear implication is that more money will flow to passive strategies, more poor managers will be driven out of business, and, crucially, fees will remain under pressure. Technology will only make this process faster and smoother, giving clients more opportunities of bailing out more easily and to ever cheaper alternatives.
Of course alpha still exists, and of course, people will continue to both chase it and attempt to pay up for it. Some of them, and the managers they hire, will even be successful.
In some ways the best medium-term hope for active managers is a massive multi-asset selloff, the kind in which passive strategies suffer retirement-delaying losses. Active managers will too, but some will outperform and may find it easier to market after a severe bear market.
This wouldn’t change the alpha zero sum math, but might reverse the trend, at least temporarily.
(James Saft is a Reuters columnist. The opinions expressed are his own.)
(Editing by James Dalgleish)
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