The piece excerpted at the end of this post is hilarious. Because what it implicitly says is that everyone is perfectly happy to pretend like they became a guru in 2009 right up until everything stops going up, at which point everyone will suddenly realize that there is indeed some utility in consulting folks who actually might know how to behave in a two-way market.
To be sure, there’s nothing particularly profound in what you’ll read below from FactSet, but it does underscore the fact (because that’s what it is: a fact) that everyone has been lulled to sleep by nearly a decade of policies that have served to ensure that risk assets only move in one direction – “arcane” concepts like price discovery be damned.
Of course as we noted earlier this week (see here), the problem is that the people who are piggybacking on that dynamic are now perpetuating it, creating a veritable perpetual motion machine that blurs the line between good decisions and decisions only turning out good by virtue of you and everybody who looks like you having made them.
Naturally, that should create opportunities for active management – and indeed, Wells Fargo argues that the active crowd is learning how to pick off the “dumb” money. But the true “turning of the tide” will come when things start moving in the “wrong” direction. That’s when it will become clear that expertise isn’t something the world no longer needs.
The only question will be whether, after years of being ostracized and summarily dismissed as irrelevant, the people who actually understand how to trade will still be willing to pick up the phones. And that’s assuming they still have jobs by the time the next correction actually rolls around.
More below…
While 78% of global institutional assets remain in actively managed accounts, according to research conducted by Greenwich Associates earlier this year, that share is expected to drop to 74% by 2020. Most of the asset management executives interviewed said they believe that the trend will continue for several more years before equilibrium is reached.
Over the last nine years, as the global economy emerged from the financial crisis, global monetary policies have facilitated low, or even negative, interest rates to stimulate local economies. These policies were implemented to provide a tail wind to bolster the prices of all risk-bearing assets and increase correlations between and within asset classes. Many argue that these conditions have provided a natural advantage to passive funds–when correlations are higher and more predictable, the opportunities for active outperformance are lower.
We are now moving into a new and less certain economic regime that will include rising interest rates and a return of fiscal policy–including tax cuts and infrastructure spending–that targets specific areas of the economy rather than the economy as a whole. These conditions could lead to a more uneven growth trajectory for countries, industries and, ultimately, asset prices going forward. Given this, the more uneven growth rates and “normal” asset-price correlations should naturally benefit active portfolio managers, which are able to take advantage of mispricings and emerging economic trends.
Bear Market: Catalyst of a Shift Back to Active?
Many portfolio managers feel the most likely catalyst for a shift back to active is not the changing economic environment, but instead a bear market. For nearly a decade, investors have been happy to gain exposure to the current bull market cycle via low-cost beta strategies. Should the markets begin to reverse, however, investor goals will turn to capital preservation and limiting losses.
In that environment, many institutions will be willing to pay higher fees for an active manager who can provide additional service and a customized investment strategy. This logic makes sense, as hands-on guidance is sought during tough times. However, it should be noted that there is no clear empirical evidence that actively managed funds have outperformed indexes in bear markets. Additionally, it is a pessimistic view of the future of the industry if actively managed funds are only of value during a down cycle.
There was a strong sense among respondents that the current passively dominated investment strategies would eventually lead to misvaluations in asset prices. To the extent that misvaluations caused by high levels of indexing, skilled active managers should be able to identify these situations and use them as an opportunity to outperform.
Other study participants feel that active managers could start attracting net inflows only by outperforming their passive counterparts. In other words, performance rules all. Naturally, investors will be willing to pay higher fees if it results in greater risk-adjusted net return.
