The sentiment for active management among financial professionals was already strong in the latter half of 2017. In fact, 75% of institutional investors agreed that the current market environment is favorable for active management, in the latest Natixis Investment Managers Global Survey of Institutional Investors1. The table below depicts what institutions think active managers are best suited for in their portfolios, according to the survey.
Active trends in portfolio construction
In 2017, choosing active managers did pay off, according to Natixis Portfolio Clarity® trends analysis of moderate portfolios submitted to the portfolio analysis service focused on risk and efficient diversification2. Marina Gross, Director of Natixis’ Portfolio Research & Consulting Group in the US, points out that the top-quartile performing portfolios had high exposure to active managers in 2017. “These top-quartile performers had 3% more exposure in active managers,with portfolio expenses two basis points (bps) higher, and outperformed bottom-quartile portfolios by 520 bps,” said Gross. She also noted that portfolio expenses have been declining for the past five years. “Despite higher allocation to active managers in 2017, the average portfolio expense has dropped to 67 bps within the ‘moderate risk’ peer group, down from an average of 84 bps in 2013,” said Gross.
Case for active in US large caps
Not surprising, passive weight in portfolios remains concentrated in US equity strategies, according to analysis by Natixis Portfolio Clarity®. However, that doesn’t mean truly active strategies – ones with high active share3 – in this category didn’t outperform the S&P 500®, or out-earn their fees, last year and over the long term. Bill Nygren, Chief Investment Officer, US Equities, and Portfolio Manager at value-focused Harris Associates (advisor of Oakmark Funds) has heard many arguments for why the US large-cap space is better suited for passive investments, including it’s too competitive, too expensive, and the US isn’t very interesting compared to the rest ofthe world. He challenges all of these assumptions.
“I think right now is an unusually opportunistic time to be an active manager in US equities, but the world right now seems to think otherwise,” said Nygren. A high-conviction, concentrated portfolio manager, Nygren and his colleagues at Harris Associates rely on their consistent value discipline and stock-selection process to drive performance for shareholders – not the benchmark.
"I think right now is an unusually opportunistic time to be an active manager in US equities, but the world right now seems to think otherwise," said Nygren.Regarding risk in portfolios, Nygren argues that the average investor today, as well as many equity consultants, tends to think about risk as how much their returns might differ from the performance of the S&P 500® Index. “That is a definition of risk that we reject at Harris Associates,” he said, adding “We take more of an old-fashioned approach to risk management. We think about risk as losing capital. Each of the factors we look for in our companies – selling at a big discount to what we think the business is worth, that value is growing over time, and managements are aligned with shareholders’ interests – we believe simultaneously reduces the risk in our portfolios, and increases the prospective return.”
Risk avoidance advantage
Scott Weber, a senior portfolio manager at Vaughan Nelson Investment Management, takes a similar view on risk avoidance. “We have a number of risk tools. The first one: don’t overpay for a stock. It’s that simple. Valuation discipline is paramount. We follow a consistent process looking for idiosyncratic stock opportunities. When, and only when, Mr. Market gives us the opportunity to achieve our return criteria will we allocate capital,” said Weber. Overall, he describes the active investment philosophy at Vaughan Nelson as trading time for value.
Looking out at shifting market dynamics, Weber believes high active share managers should fare considerably better than passive managers when central banks’ tightening of monetary policies begins to dry up some of the liquidity in global financial markets. “Liquidity moves markets. We have had an unprecedented, close to $20 trillion of liquidity supplied by the G4 central banks. That number is now getting smaller, not bigger,” said Weber. Alpha contribution, he believes, may become disproportionately favored versus the beta in portfolios, as a result.
"Liquidity moves markets. We have an unprecedented, close to $20 trillion of liquidity supplied by G4 central banks. That number is now getting smaller, not bigger," said Weber.Allocate towards opportunity, away from trouble
Loomis Sayles’ Global Allocation equity manager, Eileen Riley, has seen firsthand how a consistent active management approach can deliver results for clients over a variety of time periods. She feels particularly fortunate to be supported by Loomis Sayles’ global research platform, which helps to keep her team well informed and ahead of disruptions occurring across several industries today.
“The pace of change right now in industries, on a global scale, is moving much faster than it has in recent history. Obviously, technology is the big enabler. But we are seeing disruptions across industries – retail, media, healthcare and consumer products, to name a few. When you have that kind of rapid change, it makes it difficult for some businesses to keep up from an execution and strategy standpoint,” said Riley. As a result, her team recently exited a stock because its competitive advantage in retail distribution changed dramatically. “It used to be having a widely distributed product was a competitive advantage for this particular suite of products; now with increasing price transparency as more retailers develop on-line capabilities, it can be a disadvantage. It challenges retailers’ ability to maintain price, and then in the end the value of brands over time.”
"In our minds, today is a great opportunity for security selection - to buy the right businesses, as opposed to buying an index, or the market," said Riley.Disruption certainly delivers risk, but also opportunity, Riley believes. “In our minds, today is a great opportunity for security selection, to buy the right businesses, as opposed to buying an index, or the market,” said Riley.
While there is always a place for passive investments in portfolio construction, high active share strategies should never be overlooked, especially when global change and disruptions are under way.
The views and opinions expressed represent the subjective views of the contributors. They are subject to change at any time based on market and other conditions. There can be no assurance that developments will transpire as forecasted. This material is provided for informational purposes only and should not be construed as investment advice.
All investing involves risk, including the risk of loss. There is no assurance that any investment will meet its performance objectives or that losses will be avoided. The ability of an actively managed investment to achieve its objective will depend on the effectiveness of the portfolio manager.
1 Natixis Investment Managers, Global Survey of Institutional Investors conducted by CoreData Research in September and October 2017. Survey included 500 institutional investors in 30 countries.
2 Source: Natixis Portfolio Research & Consulting Group (PRCG). Based on 228 “moderate risk” model portfolios submitted to PRCG from July 2017 to December 2017, 312 “moderate risk” portfolios submitted to PRCG from July 2016 to December 2016, and 307 “moderate risk” portfolios submitted to PRCG from July 2015 to December 2015.
Performance data shown represents past performance and is no guarantee of, and not necessarily indicative of, future results.
3 Active share is a measure of the differentiation of the holdings of a portfolio from the holdings of its appropriate passive benchmark index. High active share is considered between 80% and 100%. For example, an actively managed fund with an active share of 90% means that the relative security weights of the portfolio are 90% different from its benchmark.
High active share is not a guarantee of outperformance or positive performance.