Active Managers Can and Do Outperform Their Indexes – Nasdaq Trade Talks (5 min)

In this interview with Nasdaq Trade Talks, David Lafferty, Chair of the Active Managers Council and Natixis Chief Market Strategist shares his thoughts on active management, why the argument that active is a “zero sum” game doesn’t align with how managers are measured, and how to identify outperforming active managers.

“There’s been an unbalanced narrative in recent years that passive is winning in all places and in all times,” said Lafferty. “That’s really not true.”

The idea of active management being a “zero sum” game, that active management has to underperform because of fees, doesn’t line up with the way active managers are measured, Lafferty elaborates. While alpha in general has to equal zero, it doesn’t mean it will fall equally among managers. It can be dramatically skewed. Some managers with a lot of assets and outperformance could be taking alpha from a fewer number of underperforming managers.

On identifying outperforming active managers Lafferty advises investors to focus on three things – cost, longer term horizons, and portfolio differentiation.

Lafferty indicates manager selection is “not this needle in a haystack exercise.” Academic research shows that fees do matter. Morningstar has data on the effect of buying lower expense managers. Finding portfolios that are active enough and don’t look like/hug the benchmark, combined with managers that tend to have a longer horizon, that are more focused on real fundamental change and not focused on the day to day noise are critical.

Passive Investing ‘Is Not a Strategy’: Ariel Exec - ThinkAdvisor

Active Managers Council member and Ariel Investments' Rupal J. Bhansali makes the case for active value funds in Bernice Napach’s ThinkAdvisor piece, stating, “passive is not an investment strategy … it’s owning past success.”  

Bhansali’s new book, “Non-Consensus Investing,” explains that passive investing dominates the stock market, creating the risk of “owning overvalued assets and contributing to price distortions and market inefficiency…When too much money chases too few goods, it bids prices up simply through technical demand/supply imbalances, not fundamental factors.”

In layman’s terms, active management has greater potential to outperform in down markets. The active fund category includes closet active funds that “hug” their benchmark” and “pseudo active” funds that are “formulaic,” using measures like low multiples or low price-to-book multiples to pick their stocks rather than doing fundamental research.

Truly active funds do that research and have a high active share, low turnover and a portfolio manager who invests in the strategy and manages risk, Bhansali concludes.