Rising scepticism among investors globally with regard to the effectiveness of active asset management has prompted Watson Wyatt to emphasise what it identifies as particular asset classes where manager selection can add value.
At a reception earlier this week in Hong Kong, Naomi Denning, managing director of the firm's Asia investment consulting practise, told a group of fund management executives that Watson Wyatt was trying to present a holistic view about asset classes. Too often asset owners are looking at manager-related decisions within the confines of one asset class.
Craig Baker, London-based global head of manager research, presented the firm's ideas by identifying what makes an asset class a rich or poor environment for fund managers to beat the benchmark.
Recognising that active management is a zero-sum game - in fact, a less-than-zero sum game when one accounts for fees and transaction costs - the active management industry has also been poorly framed by its attention to track record and past performance.
Baker notes that if one just looks at performance to identify the truly skilled managers, the time required for a confident opinion is 12 years. This of course is an untenably long time; even should an investor wait so long to find the answer, the fund manager's team and organisational background would have surely changed.
Another problem with picking fund managers is more about the un-picking (ie the firing) of them. An investor can correctly identify a skilled manager that then stumbles into a spell of bad luck. A decision is made to fire the manager, which eats up time and resources, and probably makes no sense -- but tell that to the board of trustees.
Nonetheless, Baker argues for those investors with the capacity to make such decisions, the rewards of picking out-performing managers makes the exercise worthwhile. Those rewards vary by asset class, however, and he notes that consultants such as Watson Wyatt have found the utility of their own manager shortlists also depends on the asset class.
The fundamental problem is the data sets that people use. For some asset classes, the sample size is small, or the history is too brief. The definitions are unclear, so that a few tweaks to assumptions can produce wildly varying outcomes. Survivorship bias is always prevalent (the failures have removed themselves from the data).
"All the data is historic, yet asset classes are constantly evolving," Baker notes.
Despite these issues, he says Watson Wyatt has been able to identify good managers in some asset classes because of a range of factors that make such picks more credible.
Such environments will offer a big universe of managers; the presence of 'non-profit' investors, such as in certain parts of fixed income where local public entities are required to participate, or where passive mandates are prevalent; the existence of informational asymmetries; market inefficiencies; and enough capacity in the best managers to allow for investors to get in.
Similarly, the ideal asset classes will also involve reasonable fee levels, modest transaction costs, and low fees for other services such as custody and administration.
Baker says figuring this out is difficult to do simply by running a spread sheet; it requires qualitative analysis. (Which is presumably the sort of service that Watson Wyatt would like to proffer.)
Baker says global equities is one asset class that does allow for identifying superior, active fund managers. It does not tick all of the boxes, but it is good enough.
For example, it offers breadth, with plenty of ways to make money off piste; over short periods of time there can be plenty of inefficiencies to exploit; and capacity issues are minor, with plenty of quality fund managers able to take your money today.
The downsides: information is widely researched and disseminated, and there are no 'non-profit' participants, although the ranks of passive investors are growing.
Comparing management fees, trading costs and administrative charges, the active world costs about 95 basis points more than the passive world in global equities. This is surmountable.
Overall, then, the costs and the downsides in global equities are outweighed by the opportunities to make money. Watson Wyatt therefore argues that active asset management makes sense in this asset class.
Of course, the decision about active versus passive must include broader questions, such as the investor's own expertise and resources to handle investment issues. The risk budget, willingness to outsource and strategic asset allocation must be set first.