Hallmarks of Successful Active Equity Managers

Hallmarks of Successful Active Equity Managers

As a Firm we are proponents of combining Active & Passive managers to optimize the risk-adjusted returns. Our business is building unique, core, strategic, passive models that provide market returns or beta at a low cost. While there are many reports written about why active management does not make sense as it adds minimal value, I came across this report which talks about why and how active managers might make sense. The following is a summary from this report written by Cambridge & Associates, on the above topic:

• The debate about “active versus passive” investment management has received considerable attention. The average active equity manager regularly struggles to outpace the market; however, some managers perform better than average and studies generally conclude that some managers do exhibit skill. As a result, we attempt to answer a different question: how can investors selecting active equity managers maximize their odds for success?
• Increasing the average performance outcome is one part of the puzzle. Academic studies of US mutual funds show that funds with higher active share or more concentrated portfolios have outperformed their more benchmark-like peers. We investigated the applicability of these findings to institutional managers with an analysis across three primary segments of developed markets equity managers since the prior global equity market peak (October 2007). We find that higher active share or more concentrated managers in US large-cap, US small-cap, and non-US equity manager universes similarly delivered attractive returns that outpaced both their benchmarks and their peer group average manager even after applying an estimate for the impact of fees.
• We also consider the use of tracking error as a tool for positively skewing the distribution of manager outcomes. Preferring managers with highly active or high-
  conviction portfolios does not necessarily equate to choosing managers that are extremely volatile. We show that being mindful of managers that exhibit extreme tracking error can help prevent investors from being on the negative side of “differentiated” performance.
• Combining insight from active share and portfolio concentration with tracking error can help investors identify managers that may be better poised for success, with both a better distribution of outcomes and a better average outcome. However, we acknowledge that investing in differentiated portfolios comes with challenges, including the limited supply of managers that invest in this fashion and considerations about investor behavior. While some may see these challenges as roadblocks, they likely form the basis of the observed relative return premiums earned by investing with these managers. In investing, the willingness and discipline to overcome implementation challenges is often the path to more attractive results.