The popularity of active managers continues to be based on past performance which is sold to and not bought by investors according to senior executive with a major indices provider.
S&P Dow Jones Indices global head of index investment strategy, Craig Lazzara, also claims the popularity of active management has been based on the premise that past results predict future performance.
“It is normal behavior to pick the best of the past and in most parts of life this is the right way to proceed, just not in investments,” Lazzara said.
“Active managers tend to be sold and not bought and the reason for this is found in the persistence scores and if they are examined over a five year period are there active managers who are consistent year on year?”
“This idea of persistence is the same as a coin toss with the same chance of getting heads four times out of four. The active managers that are consistently above the benchmark are very few,” he said.
Lazzara said active managers were better than their counterparts from 30 years ago and had better education, access to information and technology and the benefits of modern portfolio theory.
“The problem today though is they are not competing with the managers of 30 years ago. The level of the game has been raised very high and it is akin to batting 400 in baseball — it is harder to do because everyone has become better at what they do.”
“As skill improves and disseminates it is harder to create alpha generation and fund managers are competing with the same advantages as other managers with the possible likelihood that same may not have those advantages anymore.”
Lazzara said despite these concerns more active funds are benchmarked to S&P indices than passive funds and the emergence of smart beta funds was part of the nuance needed to find a balance between active and passive management.
“We estimate around 70 per cent of funds are actively managed with the rest passively managed but our own research found that 55 per cent of those active managers routinely underperform the benchmark. Thus it is interesting that passive investments are so low,” Lazzarra said.
“Given their tendency to underperform the benchmark, and the validation of that fact via research, it would be expected that there should be more invested in passive investments.”
