United Artists/Courtesy Everett Collection
Don’t call it a comeback — yet.
Active management, which over the past several years has been essentially abandoned amid a long-term shift toward passive investing, has shown an improved performance of late. But that may not be enough to bring investors back into its fold.
According to data from J.P. Morgan, 53% of active managers outperformed their benchmark in the third quarter, a notable improvement from the 41% that outperformed in the first quarter and the 34% that beat their benchmark in the second quarter.
Active management—for which the components of a portfolio are chosen by a team or individual as opposed to being pegged to a benchmark, as they are in passive investing—tends to outperform when market swings create more opportunities for the managers to diverge from their benchmarks.
The improved performance came during an unusually volatile time for markets, occurring after Britain’s unexpected vote to leave the European Union in late June and ahead of the early-November U.S. election. In fact, the last time active managers outperformed by the current degree was during the dot-com bubble of the late 1990s, said Andrew Slimmon, the lead portfolio manager for long-equity strategies for the Applied Equity Advisors team at Morgan Stanley Investment Management.
“The reasons for the outperformance then are consistent with what we see today,” he said. “In 1999 there was a group of stocks within the market—technology stocks—that were very expensive, and managers avoided them, to their favor. Now, there is a very expensive group of bond-yield surrogates that a lot of managers seem to be avoiding.”
And because yield stocks have started to deflate, the percentage of active managers outperforming rises, as shown in the third quarter.
Markets have risen in essentially uninterrupted fashion of late resulting in a waning of volatility. The CBOE Volatility Index /zigman2/quotes/210598281/delayed VIX -4.85% is currently trading under 13, well below its long-term average of 20. That could indicate that the active outperformance was temporary. J.P. Morgan noted that so far in the fourth quarter, 45% of active managers are outperforming their benchmark, while for 2016 as a whole, only 33% are.
Other studies also show that an overwhelming number of active managers fail to beat their benchmark over the long term. That, along with the generally lower fees of passive funds, has led to investors moving away from active en masse. According to data from Morningstar, $217.1 billion has been pulled from actively managed funds so far this year, while $358.3 billion has flowed into passive funds. That continues the rotation seen during 2015, and the theme is expected to accelerate next year, when the Labor Department’s “fiduciary rule” is scheduled to take effect. With it, rules around how manager act in their clients’ best interests will toughen.
“A random choice of managers would suggest you buy passive, because fewer than half outperform, historically,” Slimmon said, though he argued that active management could still hold a place in an investor’s portfolio.
“The active managers who do the best over time are the ones who have a high degree of active share, meaning the degree to which they don’t look like their benchmark,” he said, adding that it was difficult for a manager to outperform after fees if their active share was below 80%.
“The drawback of this is that you can go through periods where you don’t perform spectacularly. If you’re looking for an active manager, you need to choose someone who has a great long-term track record, who doesn’t mimic their benchmark too closely and you need to find them when they’ve done poorly. That’s best, but it is hard to do.”