For instance, after underperforming by 1.95 per cent in the 12 months to May 2007, active Aussie equities managers outperformed by 0.88 per cent in the 12 months to May 2008 – a trend which could be expected to continue for the next two years according to an analysis of previous similar periods (see table). Gunning says that managers need two things to outperform their market: skill and an opportunity set to demonstrate that skill. In most markets managers have a rough time outperforming when cross sectional volatility is low, because this reduces the opportunity set. “But now volatility is back with a vengeance … active managers like markets that are not narrow,” Gunning said. Russell also looked at whether ‘older’ managers tended to lose their ability to outperform – “do managers lose their mojo with age?”

There is some evidence of this, given the well-known ability of boutiques and especially early-stage boutiques to outperform. The Russell research indicates that there appears to be mean reversion in active management. Gunning says: “If you can time the alpha cycle that would be a great tool. But we’re not yet confident enough in that to put it into practice.” A big wild card over the short-to medium term is the intervention of the authorities in the markets. The use of derivatives, securitisation, the acceptance of short-selling and relaxation of currency and other restrictions over the past 21 years have improved the efficiency of the financial system.

In times of crisis these are scrutinized by governments and central banks, which are prone to short-term ‘remedies’, such as the bans on short selling. In a similar fashion, in years gone by, governments have introduced prices and wages freezes to attempt to stop inflation. Such moves, economists will normally argue, do more harm than good. The current crisis and the reaction by the US government, and even our own ASIC, will provide valuable case studies for the next generation of investors. Was intervention worth the cost? Would the markets have sorted the problems out more quickly or more efficiently? Will a stifling new round of regulation follow on from government intervention? At least investors can take some heart from the likelihood that their active managers have re-entered a cycle of outperformance if history is a guide.