Active managers are back thanks to the pitfalls of the passive investing trend uch has been written about “the rise of the machines” and the “passive rotation” edging out active managers in recent years. While there are no signs of the debate ebbing, as t
MSo, what has changed?
We are now in the early stages of a major regime shift, from monetary to fiscal policy, deflation to inflation and low volatility to high volatility. Central banks are looking at normalisation, correlations are crashing and we’re starting to see “shake-out” pressure on low-alpha active managers, which reduces competition for alpha among the winners. As a result, alpha generation has been very robust in the last year.
Active managers can use qualitative judgement to screen the best opportunities that may be expected to outperform over the long term – stocks that may be undervalued, particularly high quality or from less efficient parts of the market. They can offer downside protection and even capital growth during a downturn. And they can concentrate capital in big ideas. As authors Kristian Heugh and Marc Fox have written: “Conviction reduces the possibility of being shaken out of undervalued ideas based on short-term noise.”
Most things in finance are cyclical.
Central banks are looking at normalisation and we’re starting to see “shake-out” pressure on low-alpha active managers
Now the tide seems to have turned in favour of active management, with stock selection again adding alpha in rising markets while dampening volatility in down markets. That said, the requirements for active managers will likely become more stringent, requiring more reliable alpha generation. Successful managers will be those that have the “active DNA” that leads to sustained performance.
This means high active share – no closet index hugging while purporting to be active – lower turnover, diversification by geography but with a focused strategy and an ability to operate in the most inefficient parts of the market.
The silver lining of the passive dominance over the past few years is that as passive has grown, there may be more alpha available. That has helped give rise to a new paradigm in the active management industry.