October 2019

Debunking Myths About Active Management

On the Bloomberg What Goes Up podcast last week, Dave Lafferty, Senior Vice President and Chief Market Strategist, Natixis Investment Managers and Chair, Steering Committee for the Active Managers Council, had the opportunity to discuss the Council and its work debunking false narratives about active management. Following is a quick summary. Lafferty’s commentary can be found at the 26:45 mark:

• The Council is a group under the IAA whose mission is to counter the false dichotomy that pits active against passive. 
• The Council is not anti-passive, but rather is supportive of both active and passive. The Council is simply  balancing an unbalanced narrative that passive is good and active is bad
• Lafferty then quickly debunks three common false narratives about active:

• Scorecards and other performance measures that are often cited to support the claim that active doesn’t work are just wrong. The Council’s research and analysis find that many active managers can outperform, especially outside of US Large Cap.
• The zero-sum game argument for why active can’t outperform is also flawed because of the way they measure managers. Average dollars might not outperform, but individual managers can. 
• Lastly, Council research counters the idea that finding a good manager is a needle in a haystack exercise.  In fact, there are key attributes and indicators investors can use to improve their odds of finding great managers.

Active Management: Crucial to Market Efficiency

Active managers play a crucial role in the market efficiency, ensuring that stock prices are fair, says Professor Russ Wermers of the University of Maryland - warning that tilting too heavily toward passive management will cause dislocations in markets.

In this video, produced by the Active Managers Council, Professor Wermers briefly highlights findings originally distilled from his paper, “Active Management and Market Efficiency.” The paper, published earlier this year, focuses on a critical contributor to market efficiency: the activities of active investment managers. 

The paper concludes that “all investors, both active and passive – as well as the real economy – benefit from the efforts and cost expenditures of active managers.” Not only do active managers generate “value-added for investors,” Wermers notes, they simultaneously make “public security markets more efficient.”

Passive Investing Hasn’t Taken Over the World – Bloomberg Opinion

This Op-Ed, written by Barry Ritholtz illustrates a very different future for active management, than what is being widely reported in the media, labeling all the “talk” about passive taking over the investing world as “hype.”

Ritholtz cites data that paints a very different picture globally for active/passive AUM. “Active management in the equity market, both in the U.S. and abroad, [as] dominant. And not by a little: Active management in the U.S. trounces passive by a ratio of 8-to-1 in dollar investments.[i]  Expand that to include the entire world, and the ratio is closer to 15-to-1. If we include fixed income in our calculations, the ratio balloons to 60-to-1.[ii] 

“Although passive investing has made significant inroads in the U.S., it is much less prevalent internationally. That may change over time, as investors overseas come to recognize the advantages of low-cost passive indexing. Regardless, add a reasonable estimate of non-U.S. index funds (about $1 trillion by my estimates) to U.S. passive equity funds, and the total of indexed equity capital rises to about $5.3 trillion worldwide. This puts the passive market share of global equity at about 6.4%. (Note, this excludes a variety of unknown holdings, including sovereign investment funds or separately managed accounts that might be passive. Include those, and global passive might be as high as 13%, according to Vanguard.)”

[i] There is no one definitive data set for the market capitalization of stocks and bonds around the world. I used a variety of sources, and while the totals never added up precisely, they were all pretty close: I used Vanguard for equity, fixed income and non-publicly traded company stock; Morningstar for equity and fixed-income flows (via Nir Kaissar); the Securities Industry and Financial Markets Association for global bond totals (via Dave Nadig); Russell Indexes for U.S. equity; and Savills for global real estate. These were reviewed against the Federal Reserve’s Z1 Financial Accounts of the United States.

[ii] For our purposes, we shall exclude private (non-public) corporate equity of about $15 to $20 trillion. Also excluded from the total: $217 trillion in global real estate; about $46 trillion of that is in U.S. residential and commercial real estate.