Active Management: Value Beyond Returns?
Active management is in trouble, we’re told.
The headlines are ubiquitous and dire: Active management’s days are numbered, if its number isn’t already up. Zero interest rates, an eight-year bull market, high fees, etc., have all contributed to the perception that active management is on the way out.
Warren Buffett, one of the greatest active managers of all time, has said that most people are better off in index funds. Putting his money where his mouth is, he placed a bet with Ted Seides, CFA, on index funds outperforming hedge funds. The Oracle of Omaha is way ahead.
Jack Bogle, Charley Ellis, CFA, and others, have all joined the chorus of active management critics. Though the ink may not be dry quite yet, active management’s obituary is clearly being written.
But it may yet be premature. As my colleague Jason Voss, CFA, wrote recently: Active management is definitely not dead.
Clearly, active managers have underperformed relative to index funds during the long bull market. But when things turn south, the thinking goes, active managers will rise to the occasion and outperform the indexes in a down market. Of course there are larger questions at work when considering the role of active managers. Is investing just about returns? Or are there other services that active managers can perform for their clients that go over and above the bottom line and add value beyond returns?
For insight on this question, we polled readers of CFA Institute Financial NewsBrief. Their responses ran the gamut. No one answer dominated the results. But if there was one key takeaway, it’s this: Despite all the ink that has been spilled heralding the end of active management, respondents to our poll still believe it can serve a purpose, independent of returns. The evidence? A mere 11% of the 682 poll participants said that active management’s time has come and gone.
Other than returns, how might active managers best add value?*
* Results do not add up to 100% due to rounding.
Aside from returns, 28% of respondents cited more personalized and responsive service as active management’s main value add. This begs the question: What is more personalized and responsive service? Certainly a form of customer care comes into play. Clients no doubt want their advisers to return their phone calls and otherwise be available to talk through their concerns and explain their strategies.
But implied in these responses is a potential reimagining of what it means to be an adviser. After all, there are few things more important than saving for retirement, to buy a home, or to fund a child’s education. Given their importance, such activities are fraught with anxiety and require a significant degree of focused consultation, if not outright hand-holding. As Bob Stammers, CFA, pointed out, trust is the most important determinant for clients in choosing an adviser and active managers can help build that trust.
One in four participants said greater flexibility to structure portfolios was active managers’ most critical contribution beyond returns. An investment is fundamentally a statement of belief. For some that belief might be simple: that a business is well run and has a sound future. To others it might be something deeper: that a business serves some purpose. Clients can be motivated by a host of factors beyond building wealth. Some want to generate returns in a way that reflects their values. Clients who are passionate about green energy, say, may want to demonstrate that in their portfolios, regardless of whether it maximizes long-term returns. Active managers have a role to play in helping construct the sort of individualized portfolios that demonstrates their clients’ values.
Tax efficiency was the choice of 22% of respondents. Certainly, active managers tend to trade more frequently than passive managers, thus incurring higher transaction costs. That said, by taking a more in-depth view of a client’s portfolio, active managers can invest in ways that shield clients from tax burdens.
Finally, 13% of poll respondents selected better price discovery. Indeed, as Paul Smith, CFA, president and CEO of CFA Institute, made clear recently, this service rendered by active managers benefits the whole of the investment industry, passive indexes among them.
These points are all worth remembering. They demonstrate just how broad a concept active investment is and how misleading all the active management death watch stories can be. After all, constructing a passive index fund is itself an active endeavor. And as Smith said, “Passive investing wouldn’t make anybody any money without active investing.”
The verdict from this data is clear: Despite all the negative headlines, active management is still breathing, at least among readers of CFA Institute Financial NewsBrief. And while stock picking may have fallen out of favor for the moment, active managers still can provide services to their clients that they can’t get from passive funds.
To be sure, that doesn’t mean that active management doesn’t deserve the criticism it has weathered in recent years. But active management is a big tent, and as such, has its share of acrobats as well as clowns.
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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.