The debate surrounding active versus passive portfolio management has been with us a long time. Get used to it. Just like the argument about which is the better NFL franchise, Cowboys or Packers, the case for both are rational and passionately defended.
Passive vs. Active
Which works better? It depends on who and how many you ask. It depends on the timeframe. It depends on what is meant by “better”. John Rekenthaler of Morningstar was recently quoted in a WSJ article saying: “Active will never die.” He’s probably correct, but active will need a better environment in which to operate and not all active managers will survive. Over the past few years, it seems active management has been the victim of low volatility and very good index returns. A white paper by RVK investments studied excess returns of active large cap managers under different dispersion environments and concluded that high dispersion (volatility) and index return levels drive active management relative performance. When an index shows strong returns, active management trails. When dispersion of returns are low, active trails again.
Market cycles are persistent and deliver the beta both good and bad. But beta is not what we’re looking for in active management. We want alpha and it’s alpha our clients pay for. Where do we look to find the best active mangers? What are some of the characteristics of superior managers?
American Funds describes the three most important characteristics of a good manager:
1) Low Fees
2) Protecting the downside
3) Manager ownership of the fund
These are all good, but they lack completeness. Northill Capital reported in a 2016 paper that a focused management style was a key to delivering alpha. A focused fund manager delivers value by adopting a business model that commits all of the management time and resources to a single investment process. These managers target specialization in one asset class and are not distracted by bringing new products or strategies to the market. Being a generalist is just another way to underperform.
With the Salt Creek platform our strategies and processes are aligned with several of the traits mentioned above with discipline and objectivity being the hallmark. But, just as important are our strategies which are unique and offer our clients a real opportunity to see value, even under an asset allocation structure.
As Howard Marks once commented, “active management strategies demand un-institutional behavior from institutions, creating a paradox that few can unravel. By operating in the institutional mainstream of short-horizon, uncontroversial opportunities, committee members and staff ensure unspectacular results, while missing potentially longer-term contrarian plays.”