Under performance and high costs have given active management a bad press, some of it well deserved. But it appears to be on the brink of a renaissance with some LGPS managers seeing it as a force for good.
Investment officers at the Room151 LGPS Asset Allocation Forum in November revealed that despite the rise of passive managers, there is still a place for their active counterparts.
While active management has received criticism, speakers at the forum, held at the London Stock, certainly believed it could be worth a punt under the right circumstances.
Some even thought that the dominance of ESG (environmental, social and governance) factors opens up new opportunities for active managers.
Mark Mansley, chief investment officer at Brunel Pension Partnership, offered an emphatic endorsement: “We do fundamentally believe in active management as an option for investors.”
Human touch
Active fund management—the use of a “human element” (analysis, research, individual judgement) in fund management—has fallen out of favour in some circles, due to the failure of many managers to match or better index linked funds.
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In July the Financial Times reported that $30bn had been pulled so far from US and European active funds in 2019, the highest rate for three years.
In May, Morningstar, a firm of financial analysts, reported that the volume of assets passively managed in the US now equalled that of actively managed funds, around $4.3trn.
In the UK, of the £1.2trn under management, around a third is passive, according to the Investment Association.
Passive management looks like it minimises risk and has certainly grown in favour, but there are those who see real benefits in active management.
Four
According to Mansley, there are four major reasons why active management should be reconsidered.
Firstly, despite problems with performance, evidence is available to show that certain active approaches do work.
Secondly, passive management is a “naive” approach to risk management; active can be more sophisticated.
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Next, the old complaint about the higher price of active management compared to passive has been undermined by a diminishing cost differential.
Lastly, active management offers “powerful opportunities” for stewardship. Related to this, active management also offers a way to enforce “good market conduct”, one of the key principles for FCA regulated firms.
According to Mansley: “We should be challenging the passive managers much more strongly on that. Are they actually contributing to well-functioning markets?”
Ingredients
The argument for active management was bolstered by Jason Fletcher, chief investment officer at LGPS Central, who also conceded that there is a “long tail” of active managers who fail to beat the market.
Fletcher’s argument is that success is really down to spotting the ingredients for outperformance among active managers.
According to Fletcher, a high active share metric is a good indicator of out-performance. Others point out that active share stats can also enable asset owners to spot “closet” passive managers.
Fletcher observes that there is also evidence that when managers have “skin in the game” they do better.
But, he warned, managers should be linked to the downside as well as the upside of their management decisions.
The personalities of active managers can also make a difference. According to Fletcher: “Managers that outperform tend to have high conviction. On the other hand, they have the humility and the ability to learn from mistakes.”
LGPS funds work well with active management because of the economies of scale they offer due to their size.
And as long-term investors, LGPS can reduce costs by reducing investment turnover.
Fletcher also says there are other advantages to active management.
The economy benefits because index funds tend to favour only large, well-established companies.
“Essentially, we’re giving money to the biggest companies in the world…who may not actually need that money, and we’re giving them the lowest cost of financing,” said Fletcher.
And he echoed the earlier point that active management enables better engagement with companies, especially on ESG (environmental, social and governance) issues.
Gift
According to Piers Hiller, chief investment officer for Royal London Asset Management (an investment manager providing both active and passive arrangements), the advent of ESG as a headline issue “has been a gift” to the active management industry.
The reasoning is this: It reminds active managers that they have to deliver “long-term outcomes”.
And it can also follow responsible investments. The great advantage, Hillier points out, is that if capital is tied up in passive funds it cannot be sold; it tracks an index.
Active managers, faced with concern about ESG factors, can sell up and move capital to a company that has its act together.
“Active managers have a place, in some ways, in making sure that we’re allocating to those that are [thinking about the impacts on the environment and society as a whole], but are also prepared to change and evolve.”
Disruption
There is also a case that active management is better suited to a world where technology has so disrupted markets that the classic finance theory of mean reversion—an asset price always reverts back to its long-term mean value over time—no longer holds true.
“Mean reversion does not exist in a disrupted world,” according to Geraldine Sundstrom, managing director and portfolio manager for asset manager PIMCO.
And yet, passive management is growing in popularity when it is an inherently backward looking form of investment, unlike active.
“We’re moving towards passive, we’re moving towards quants,” Sundstrom said, “which can only look at the past.
“But the shale oil revolution will not mean revert. The Amazon effect means that real estate, the retail sector and shopping malls will not mean revert.”
Passive management may have qualities to boast about. It has provided lower cost investment and offered more reliable performance.
However, earlier this year the Financial Conduct Authority concluded passive management may have undermined corporate governance in companies and led to a decrease in “informed trading”.
At the LGPS Asset Allocation Forum it was clear that some experts still believe that, in a world concerned by long-term outcomes and ESG factors, there is still a place for active management.
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