Over the past 12 months the cross-sectional volatility in the Aussie equities market – or dispersion between the best performing and worst performing stocks – has been at its highest level for six years. “But even if you go back two years,” Carruthers says, “I’d still argue the case for active management.” He points out that alpha and beta are not mutually exclusive, but alpha seems to be continuing to rise in Aussie shares. “The numbers show it’s a great time to be active,” he says. “There are times when you’d probably rather be index tracking but now is not that time.” While fees represent a big factor in the active/passive debate, they are not the only factor.
The cost of selecting and monitoring active managers is a concern, as is the possibility of being too diversified such that at the portfolio level the net effect will inevitably be close to index performance. Daniel Needham, general manager, investments, at Intech Investments, says that for big funds it may be difficult to have a meaningful allocation to some active managers because of limited capacity. “For example, a good manager might not want to take on $2 billion at very low fees,” he says. If the fund spreads the money around further, it may then feel that it is not on top of the job of monitoring all the managers.
“Before making the decision to go active, you need to look at the asset class and decide whether you’re likely to be rewarded for being active,” he says. Passive management tends to make more sense in some markets, such as Australian listed property, according to Needham. The listed property market in Australia is very narrow and there is not enough left on the table to be active in it, according to Intech. Credit markets, on the other hand, have asymmetrical risk, with upside limited by the spread.
The index is issuer driven, with more than 10,000 securities, and hard to replicate. Passive credit managers have to have fairly concentrated portfolios. Fundamental indexing, which takes account of various value-orientated factors rather than simple cap weighting, makes more sense in credit markets. Intech has created its own indices in global listed infrastructure, with Vanguard, and global CPI-linked bonds, with Barclays. Whenever there is a trend in investment management a lot of investors inevitably jump on board at the wrong time.
One of the biggest swings to indexing equities occurred in the US in the late 1990s after the five-year US bull market had run. The market subsequently produced three negative years in a row, with active managers outperforming as value came back. Mercer data shows that the trend to so-called ‘high conviction’ managers over the past few years is unlikely to have delivered the sort of returns investors would have hoped for. Higher tracking error managers in the long-only space, which is where high conviction or concentrated managers can be found, have worse performance on average than lower tracking error managers.
