I know two institutional executives, one in a Fortune 500 defined benefit pension fund, the other in a municipal pension fund, then a foundation. believes they will focus on active management. For them, 100% active quota is not only fine, but desirable. Of course, anyone who knows even a little bit about the statistical odds of choosing a high-performing active manager knows how incredibly misguided this approach is.
That’s why I ask true followers of active management to share their academic and professional insights on why active management is the better way to go. I find it surprising that so many people in our industry, when voicing some opinion on everything, provide few strong, substantiated sources of information to back up their point of view. rice field.
For me, there are six observations detailed below that guide my approach to active and passive questions. Of course, they are not exhaustive.
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After all, choosing a manager is never an easy process. The underlying premise begins with the assumption that active managers are likely to perform well and that those managers can be identified in advance. While the literature on manager selection certainly contains a vocabulary and a rational framework for thinking about the challenge, the holy grail of the dilemma—knowing when to transition to active and when to transition to passive—still remains. elusive.
In fact, positive analysis hinges on reasonable predictions of pre-alpha. and Active risk mitigation from both an alpha optimization and strategic asset allocation perspective.
To properly serve our clients, we need to keep an eye on these issues. The performance of active management is dismal. The SPIVA study paints a rather troubling picture.that’s right win the loser’s game By Charles Ellis, CFA, and “The Active Management Delusion: Respect the Wisdom of the Crowd,” by Mark J. Higgins, CFA, CFP. Just last month, Charlie Munger described most wealth managers, namely us, as follows: “A fortune teller or astrologer withdrawing money from a customer’s account.Munger is always great in one word, but the criticism stings and perhaps a little too much to point for many of us.
Still, I have not given up on making all active things passive. But I’m seriously considering how I’m going to overcome these challenges with my company and others in the industry. Without a doubt, our industry will continue to lean in a passive direction. However, it may become active. With respect to manager selection and the more general active vs. passive debate, we recommend that you keep the following in mind.
1. There are no bad backtests or bad narratives.
This is especially true for sales and business development people. But while it’s easy to build a good-sounding and compelling story, it’s a quantifiable way to analyze attribution after the fact and understand up front how that process will come to alpha. It is much more difficult to present a holistic approach. That’s a tall order, and no pitch I’ve heard has done it well.
Investors don’t have to figure it out on their own. It is reasonable to expect active managers to define and measure ex-ante alpha, especially if they are simply extrapolating from the past. But investors must either assess their ex ante expectations or have a well-developed forward-looking view of where that alpha will come from.
2. Non-market capitalization indices can help identify market inefficiencies.
This extends active management to index selection and management. Even small differences can make a big difference when it comes to the performance of sub-asset classes within an index. For example, the S&P 600 and Russell 2000 are market-weighted and designed to reflect the small-cap universe, but their inclusion and exclusion criteria are very different, which can lead to significant differences. Furthermore, variations in the index could attempt to capture well-known elements, the so-called ‘element menagerie’, documented in academic and practitioner research that too many have so easily dismissed. There is a nature.
3. Are our prejudices our friends?
If we really question the efficiency of the market, it may give us reason to prejudge certain corners of the investment world and invest accordingly. But such beliefs must go beyond common and obvious beliefs. Rather than “markets aren’t efficient because people aren’t rational,” we need something more concrete and concrete.
4. When in doubt, be passive.
We are all imperfect, but the strength of our beliefs is important. If it’s only a 7 or 8 on an ascending confidence scale from 1 to 10, you should be passive. Given the possibilities, being “warm” isn’t enough to stay active.
Five. Expenses and admin ownership can make for great screens
Do active managers charge exorbitant fees? What is the fund’s ownership structure? not.
6. Consider a core-to-satellite approach
This creates budget mistakes. For example, active exposures can be limited to within his 20%-30% of policy allocation. In this way, our passive exposure always gives us reasonable expectations of top quartile returns over the long term. The top quartile is impressive.
On a larger level, it might make sense to reframe the whole positive-versus-negative debate. Is the question active or passive? — may not be the right question to ask. Are we getting market exposure that benchmarks don’t have? Are there really inefficiencies in this market? Perhaps these are questions we should ask ourselves.
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All posts are the opinion of the author. As such, they should not be construed as investment advice, and the opinions expressed do not necessarily reflect those of the CFA Institute or the author’s employer.
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