While active management still plays a critical role in portfolios of all sizes and sophistication levels, it’s hard to ignore the reams of headlines and research notes making the case for passive.
Even hard-core stock pickers can’t ignore the increased adoption of indexed exchange-traded funds and the proliferation of “smart beta” indexes that aim to track territory that was previously the purview of active managers.
But we believe that a certain kind of active — active asset allocation — will be critically important to generating returns and reaching goals, and nominally passive ETFs should be equally important to this investment approach.
Before making the case for greater adoption of ETFs in an overall active asset allocation strategy, it’s worth a quick review of how we got here.
The post-crisis years have featured the unusual combination of a rebound in domestic equity markets coupled with exceptionally low volatility. While most agree that the past few years have been hard for active security selection, the explanations for why that’s so are varied. Some argue markets have become slaves to sentiment. Others blame higher correlations that obscure meaningful differences among companies. Still others point to the tendency for macroeconomic events to overwhelm the fundamentals of individual securities.
Regardless, for the five years through mid-2014, Standard & Poor’s reports that 70% of active stock pickers across all capitalization and style categories failed to beat their respective S&P benchmarks — and in some equity categories, the rate of managers failing to surpass their benchmark is as high as 90%. The trend is similar in much of the rest of the world.
There are, however, active managers who are uniquely qualified to capitalize on the previously mentioned global macro trends, as well as managers whose pursuit of a specific investment outcome (such as steady income or downside protection, to cite two examples) make them worthy of consideration.
We believe fundamental company analysis is likely to continue to take a back seat to macroeconomic and fiscal and monetary policy developments when it comes to capturing opportunities in global stock markets. Indeed, with many governments seemingly eager to take a more active role in managing their economies and currencies, we believe these forces will drive markets for years to come across all regions, but especially in emerging markets.