With many investors now convinced that markets will trade sideways for some time, they say beta returns should be forsaken in favour of alpha-centric returns. Meanwhile, emboldened by what they see as a fire sale in equities, many other are increasing their equity beta exposure right now. As a result, the age-old tug-o-war between active and passive management seems to have moved back to the front pages.
S&P released this report earlier in the week that was aimed squarely at those who believe active management embeds some kind of put option that protects it during market downturns. The report highlights the common assumption that active managers can move to cash in times of distress – that they essentially trim their beta exposure in response to the prevailing winds (an argument often made by hedge funds – the quintessential active managers).
But despite this apparent advantage, S&P found that less than half of active managers outperformed their benchmarks in 2008 – a period when markets fell precipitously. The report doesn’t mince words:
“The belief that bear markets favor active management is a myth. A majority of active funds in eight of the nine domestic equity style boxes were outperformed by indices in the negative markets of 2008. The bear market of 2000 to 2002 showed similar outcomes.”
Ironically, managers plying the most efficient markets – large caps – performed best, with only 54.3% of managers losing out to their benchmarks. By contrast, the vast majority of small cap managers (83.8%) were beaten by the proverbial small-cap dart-throwing monkey in 2008. (We’d expect that the potential for information inefficiencies would have be higher in small caps – leading to greater returns from active management, not less).
S&P compares the results from the 2008 bear to those of the 2000-2002 bear…
Meanwhile over at the original active management antagonist, Vanguard, researchers have also been examining the active/passive debate in the context of last year’s bear. Vanguard’s Christopher Philips writes:
“…when related data is examined in detail, we find little evidence to support the theoretical benefits of active management during periods of market stress-in fact, active managers have not consistently delivered superior performance relative to a benchmark during such periods.”
While the Vanguard analysis compares the performance of all actively managed US mutual funds to the Wilshire 5000 (S&P’s compares funds to their Lipper benchmark), the conclusion is similar. In 2008, only 38% of active managers beat the market. This was far worse than the tech-wreck, when 60% of managers beat their benchmark.
So Vanguard’s analysis is actually a little more flattering for active managers – even ignoring the one-size-fits-all benchmark used by the firm. Why? One reason might be that the S&P analysis uses asset weighted data while Vanguard looks at the “number of funds”. According to S&P, the average large cap value fund outperformed the benchmark by over 4% in 2008, but the average large cap value dollar outperformed by only half that (2.3%). So Vanguard’s funds performed better last year than S&P’s dollars.
Whither active management? Active management is becoming more passive just as ETFs have become more active. Jim Wiandt, the Editor of the Journal of Indexes sums it up well in this month’s edition:
“We’ve got a Journal of Indexes full of alpha (or purported alpha) this issue. You might ask yourself, “Why?” For an answer, you’ll need to look to the index industry AND to active managers, who seem to look more like each other every year. On the index side, you not only have more and more thinly sliced segments of the market used ever-more actively, but now even “quantitative” indexes that aim to outperform market segments. And on the active side? More closet index funds, lower fees and LESS volatility.”
Or, as we like to say, convergence.