AI view: will active outperform passive?
AsianInvestor’s editorial team set out this month to answer 10 key questions for the Year of the Monkey, having consulted a range of industry experts.
Here we present our response to question number eight: whether active funds will outperform passive funds. Our earlier predictions are available by clicking on the picture below. The feature appears in full in the February issue of AsianInvestor magazine.
Question 8: Will active outperform passive net of fees?
While macro conditions are uncertain and valuations are rich in many asset classes, we can expect the returns of active funds to be negatively skewed this year.
Such challenging conditions should, in theory, allow active managers to outperform passive funds as they can implement a concentration strategy on a few key stocks or sub-sectors.
But how to select the good ones? Performance numbers consistently show most active managers fail to beat their benchmark indices. Standard & Poor’s Dow Jones produces an annual scorecard of fund performance across sectors. The majority of active managers (70% as an average across sectors, but 98% in specific sectors) will underperform their benchmark over one year, and the situation is worse still over longer periods.
The argument against passive investing in a bear market is straightforward: why ride the rollercoaster down? Adherents to passive would say that even if markets are negatively skewed, unless it’s a crisis situation the best approach is to ride out the trough and profit from upside when positive sentiment returns.
The low-cost nature of passive also allows investors to make tactical adjustments more easily. Experience has shown passive will win the long game, particularly in the active equity space.
There are exceptions: the high-yield bond market is often considered best accessed via active investing, as passive vehicles have structural constraints that limit their ability to deal with credit risk. Nevertheless, 10-year results for the actively managed high-yield category show that over 90% of the funds underperformed the broad-based benchmark.