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July 23rd, 2020
By Scott Treacy, CFA
The first two quarters of 2020 have been very turbulent for equity markets while the fixed income market has remained steady. With all the volatility in the equity markets, it’s essential to review which active managers have been able to navigate these confusing times successfully. Fixed income has provided reliable returns, but they have not been large enough for institutional investors to meet their expected return targets. As a result, it is critical to review where active fixed income managers have been able to outperform their index in order to maximize returns. We’ve found areas of the capital markets where active managers have outperformed in the short-term (year-to-date 2020) and the long-term (5 years).
The data we reviewed has come from our asset manager research database (click here) and we reviewed active portfolios that were GIPS compliant. This data is preliminary and is as of July 15th, 2020, so any data submitted to the database after this time is not included in this analysis. The indices we used to calculate active returns include the Russell 1000 (US), Russell 2000 (US small), FTSE NAREIT (US REIT), FTSE EPRA/NAREIT Dev. (Gl. REIT), MSCI AC World (All World), MSCI World (World), MSCI AC World ex. US (AC World Ex. US), MSCI EAFE (Non-US), MSCI AC World Ex. US small-cap (Non-US small), MSCI Emerging Markets (EM), MSCI Emerging Markets small-cap (EM small-cap), Bloomberg Barclays US Agg. (US Broad), Bloomberg Barclays US Corp. Inv. Grade (US Corp.), FTSE High Yield (US HY), Bloomberg Barclays Gl. Agg.(Gl. Hedged, Gl. Multi-Sector, Gl. Unconstrained), Bloomberg Barclays Gl. High Yield (Gl. HY), JPM EMBI Gl. Div. (EMD HC/Blend), and JPM GBI-EM Gl. Div.(EMD LC).
The bounce back in performance for equity markets in the second quarter of 2020 did not make up for loses experienced in the first quarter, but it came close. The largest swing in equity performance happened in US small-cap stocks with a -30.6% return in Q1 followed by a 25.4% return in Q2. The US fixed income market, the dependable part of every investors’ portfolio, had a return of 3.2% in Q1 and a return of 2.9% in Q2. The return figures offered by US fixed income are reliable, but are not large enough to help institutional investors reach their 7% expected return targets. Let’s assuming an investor’s portfolio is 60% in equities and 40% in fixed income. If US fixed income is offering a return of 4.3%, that means the equity portion of the portfolio needs to return 9% in order for the overall portfolio performance to reach a 7% return figure. This puts a lot of pressure on the equity portion of the portfolio to perform. Over the long-term (5 years) only US large-cap equity is offering that type of return in the recent period, 10.5%.
There are certain segments of the equity market where active managers have done very well against their benchmark over the short (year-to-date) and long-term (5 years). We reviewed 773 portfolio returns across active equity. Not surprisingly, small-cap managers have been the most impressive in outperforming their respective indices. The top US small-cap equity managers have provided the most impressive active return figures at plus 40% year-to-date and plus 15% over five years. The other areas of the market that active managers have outperformed include emerging markets equity as well as the large-cap universes that include emerging markets (AC World and AC World ex. US). It’s important to note that in spite of the difficulties US large-cap managers have had at a median level outperforming their index, at the high-end there are still many active managers offering very lucrative active returns. Year-to-date we see active US large-cap managers offering active return figures of plus 35% year-to-date and plus 12% over 5 years. This highlights the fact that this segment of the equity market is not necessarily efficient, or where active management does not work, because good managers have been able to consistently outperform the Russell 1000 index.
In the short-term active fixed income managers have struggled to outperform their indices, but it’s a different story over the long-term. Year-to-date only the US corporate, US high-yield, and global high-yield peer groups were able to outperform their respective benchmarks, at a median level. However, when reviewing the 5 year active return figures, five of the seven fixed income universes reviewed were able to outperform their indices. The exceptions being global unconstrained and EMD HC/Blend peer groups. Active managers in the US corporate bond universe and the global multi-sector universe offered the most attractive active returns over five years. The 95th percentile return from the US corporate bond universe was over 4% and it was over 3% in the global multi-sector peer group.
Active US REIT managers have provided the most impressive active returns over their benchmark in the short and long-term at a median level. We reviewed 57 portfolio returns across the US REIT and global REIT peer groups. The median active return from the US REIT peer group year-to-date is over 4% and close to 2% over five years. Global REIT managers have also offered solid active returns of over 1% in the long-term.
In closing, active managers have been performing very well during the recent market volatility as well as over the long-term. Across equities small-cap managers, emerging markets equity managers, and the all world managers that include developed and emerging market stocks in their portfolio have outperformed at a median level. Active fixed income managers do well across many different segments of the market but, in particular, the global multi-sector universe and the US corporate bond universe has been impressive. Lastly, active REIT managers have done very well outperforming their benchmarks. Even in the supposedly efficient market, US large-cap equity, there are many active managers that have been able to consistently outperform the index, and they have done so by a large margin. These active returns can help institutional investors reach their 7% return targets in a very difficult capital market environment.
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