March 18th, 2019
By Scott Treacy, CFA
“Large-cap public equity markets are efficient, go passive,” is common advice heard in investing circles today – but is this truly the case? Jack Bogle, investing pioneer and founder of Vanguard, had been highlighting the benefits of passive investing since the 1970s. The idea has really taken off based on asset flows over the last decade. Assets have been pouring into passively managed products at the expense of actively managed portfolios. Not many investors would argue with the statement above based on current active manager performance at the median level.
However, it is important to note that it is the peer group’s median-level return that has struggled. Over the long term, there are particular active portfolios that consistently perform well against their peers and provide ample active returns over the benchmark, net-of-fees.
The Investment Metrics’ global asset manager database was utilized to review the global, all-world, international, all-world ex. U.S., and emerging markets large-cap equity peer groups. The 3-year net-of-fees annualized return was used for each portfolio and compared to the overall peer group, as well as their primary benchmarks. This figure was calculated on a monthly basis over the past 5 years. The portfolios that had the highest average peer group ranks from January 2014 through December 2018 are shown in the tables below. Additionally, we highlighted the average active return of these portfolios over the same time period. This analysis was done in order to identify the most consistent performers.
The decision to “go passive” with public equity investments is easy. The median active manager performance across these peer groups, over multiple time periods, is in line with their respective benchmarks. Eugene Fama developed the theory of an efficient market in the 1970s, stating that market anomalies will be immediately arbitraged away by investors, eliminating the possibility for active returns. This appears to be the case based on current active manager performance. Why wouldn’t an investor select a lower-fee product with similar returns to the active manager peer group? Additionally, institutional investors will be able to utilize their asset manager due-diligence resources in other more esoteric areas, like hedge funds and private equity investments. However, if plans were able to recognize those asset managers that consistently outperform their peers and the benchmark, the active returns are significant.
The benefit of active management is the opportunity to increase your wealth compared to what the index has to offer.
As more and more asset managers offer products in different areas of the capital markets, it’s reasonable to think the peer group median-level performance would gravitate down towards the index. Whereas, with a strong due diligence process from institutional investors, the most consistent managers are offering plans between 2% and 5% active returns (approximately) over the long term, net-of-fees (as shown in the tables below).
An added argument for public equity investment is that they are safer, providing more transparency and liquidity compared to hedge funds and private equity investments. The difficulty is finding those managers that can perform through multiple market cycles. Too many times, we’ve seen the top-performing asset manager in one period become the worst manager 3 years later.
The distinguishing characteristic of a good active manager is relative outperformance against the index and peers, through different capital market environments. In order to discover these managers, we highlighted the figures noted above. One could argue that the capital market cycle reviewed was not long enough and that economic cycles vary, adding more complexity to the asset manager selection process. This may be true, but what we want to highlight the importance of viewing performance over the long term (3+ years) and through multiple time periods. This provides investors with a higher likelihood of making a good selection.
The active returns offered from quality long-only public equity asset managers can lead to significantly more wealth for institutional investors and their plan participants. Furthermore, plan resources may be better utilized in the safer public equity market compared to private equity investments and hedge funds.
A real-world example of the added wealth created by an active manager over the index would be Washington State Investment Board’s hiring of Magellan for their global equity product back in 2013 with $800 million. You will find this portfolio in the global equity top consistent performers list below. Utilizing the net-of-fee returns from the Investment Metrics database, we found that this portfolio added $169 million over what the MSCI World index would have produced, assuming no contributions or withdrawals. This is a considerable difference that helps improve a plan’s funding ratio.
 Eugene Fama, Efficient Capital Markets: A Review of Theory and Empirical Work (The Journal of Finance, 1970), Vol. 25, No.2.
 Washington State Investment Board, “Investment Reports Quarterly Report,” https://www.sib.wa.gov/financial/pdfs/quarterly/qr123113.pdf, (December 31st, 2013).
Share this post