Is “Active/Passive” another term for “Alpha/Beta”? Not quite.

In December, we told you about plans for a new series of mutual funds constructed by combining active and passive components (see posting).  Boston-based FundQuest had always been content to provide the plumbing for the mutual fund industry – manager selection, back office support, marketing services and sales support to financial advisors.  But the firm announced last week that it has finally launched its first mutual fund based on these ideas- called “ActivePassive Portfolios” (see sales brochure). 

While this sounds like an oxymoron, it’s a great example of alpha/beta separation extending slowly, but surely, into the retail marketplace.  As a sort of pre-packaged alpha-beta solution, it reminds us of the Janus institutional offering launched last year (see related posting). 

Here’s what they say about the “optimal” ratio for the offering:

    

 

While this is a step forward for the mutual fund industry, don’t get it confused with portable alpha.  The problem faced by any product like this is that the active portion contains a large dose of beta.  Since they generally avoid short-selling, even the most active actively-managed mutual funds have a significant benchmark correlation.  Regular readers may remember this chart contain in a 2006 report by the US Federal Reserve (dark bars: mutual funds, light bars: hedge funds – see related posting):

Unless FundQuest is prepared to go way out on a limb, the chances are that these funds will have much less alpha than might initially meet the eye.  But given the skepticism the investing public has developed for Greek variables, “active” is as close as any mutual fund marketing department would want to get to “alpha“.

Notwithstanding the fact that long-only active management is essentially watered-down alpha, it has also caught the eyes of institutional investors.  Global Pensions recently observed:

“Active management, which promises outsized returns and benchmark-beating performance, has come to the fore as a key component of any modern pension portfolio…”

But the magazine goes on to warn that active management wasn’t for everyone though – citing several experts:

“Richard Lockwood, head of UK business at Morgan Stanley Investment Management, underlined one of the major disadvantages of attempting to find outsized returns from a single market: ‘Within UK equities, for example, you can only pick stocks within that universe and you’re up against everyone else. There’s so much information available that everyone else has access to as well, which means there is limited opportunity to consistently out-perform…’   

“Paul Trickett, European head of investment consulting at Watson Wyatt, said he thought some schemes – particularly smaller ones – should not pursue active management and said he felt the market was getting overly crowded at the moment…”

“Philip Saunders, head of the multi-asset team at Investec Asset Management, was more explicit in his criticism: ‘Of course there isn’t enough alpha for all. Sponsors believe you can invest assets in such a way that delivers a disproportionate share of available alpha – and by definition, not everyone can do that.'”

These challenges prompted Global Pensions to conclude that beta may not be so bad after all and that – citing one industry player who said that

“…the core/satellite approach – a central, passive holding as a ‘core’ of the strategy, with an alpha generating component on the side as a satellite – was increasingly popular with funds. ‘Beta is readily available,’ he said, ‘so don’t pay a lot for it. Spend time and your risk budget looking for the managers to seek alpha.'”

Which, when you boil it down, is exactly what it seems FundQuest aims to do.

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2 Comments

  1. Thomas
    April 27, 2008 at 4:16 pm

    If active contains a large amount of passive, then why even buy any active? Just buy passive on a commodity basis and move on. Bill Miller’s a great example of the speciousness of active.


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