Value managers, who were hurt by the weakness of financials, are well placed to buy decent stocks dumped by distressed investors as about half the market trades below book value, but investors will rely on the good managers to avoid value traps. Covered-call strategies, in which a manager sells call options against an underlying equity portfolio, can beat the index in times of high volatility, but usually break even or slightly underperform during rallies. Increasing allocation to index managers right now is precisely the wrong thing to do, according to Nigel Douglas of van Eyk.
Current and expected volatility will produce opportunities for active managers, while exposing their skill. He says alpha is more likely to be found in concentrated portfolios. The managers recommended by van Eyk display a degree of active risk of greater than 3 per cent away from the benchmark. Academic research for US equities finds that in the long-term, passive management outperforms, but that in periods of volatility, active strategies press ahead. Frustratingly though, such performance from active managers is rarely persistent.
In Indexing Versus Active Mutual Fund Management, Rich Fortin and Stuart Michelson test which method outperformed the US market in the 25-year period between 1976 and 2000. It compared the returns from various types of equity and bond funds on both a total and after-tax basis. Overall, apart from small-cap and global equity strategies, index funds outperform on both a total return and after-tax total return basis. But when economies were entering or emerging from recession, active managers took the lead, outperforming during the 1979-82, 1991-93 and 1999-00 bear markets and recoveries. But the overall results, smoothed over the years, iron out these short-term bursts.
The academics acknowledge that their results carry a strong survivorship bias, helping the active managers’ results as lacklustre mutual funds died out within the study period. But nor does it identify the minority of active managers that persistently beat the index, to the benefit of their investors. Christopher Phillips of Vanguard attempts to go one better for the passive camp in more current research indicating that active managers do not always successfully guide portfolios through bear markets, and if they do, their performances are likely to be one-time wonders.
In 2009’s The Active-Passive Debate: Bear Market Performance, average excess returns show that in four of seven US bear markets since 1970, active managers failed to outperform the index, and performance was inconsistent immediately after bear markets. It observed that a majority of active managers beat the market in three of seven US bear markets and in three of six bear markets in Europe. “Success by a majority of funds did not carry over from one bear market to the next,” Phillips writes. However, each bear market produced its outperformers: “it’s also true that in each bear market a group of active funds did outperform”.
