One widely reported theme of 2014 was the struggle of active fund managers, with the vast majority of S&P 500-benchmarked funds lagging the index over the year. But in a recent piece for Trust Advisor, Envestnet PNC Chief Investment Strategist Tim Clift says there’s more than meets the eye regarding the story.
Clift says that many of the dire active management headlines have focused on large-cap managers. “This narrow focus on one segment of the market, U.S. large-cap equities, is where the S&P 500 Index, the Dow Industrial Average, and the NASDAQ sit,” he says. “They are among the most frequently quoted and talked about indices. As a result, many investors believe these indices represent overall market’s performance, but in reality they only represent a subset. The headlines ignore all the other categories where investors put their money. A broadly diversified portfolio will not only contain U.S. equity investments but as they become more sophisticated, may likely include international markets exposure as well such as commodities, alternatives and other diversifying investments.”
And in non-US-large-cap areas, active managers performed much better in 2014. In the fourth quarter, for example, 71% of foreign large-cap growth managers beat their benchmarks. More than 80% of world bond managers beat their benchmarks, meanwhile, and nearly 90% of commodities broad basket managers beat theirs.
Envestnet looked at the merits of active and passive approaches in different environments. “Our research found that in steadily rising bull markets, passive investments provided higher returns than active ones, particularly in categories that are very efficient such as large-cap equity and intermediate-term bond,” Clift says. “In strong bull markets when everything is rising, stock selection isn’t nearly as important as low costs. The study also found that when analyzing different market environments, contrary to what occurred in the midst of the financial crisis in 2008, active managers generally produce higher alphas during bear market periods than bull market periods.” When correlations are high and/or volatility is low, passive strategies tend to outperform, he adds. When correlations are low and/or volatility is high, active tends to take the lead.
