“Active management is a sham — no wonder my returns are suspect,” writes Stuart Kirk, FT columnist and former portfolio manager, in his latest attack on active management. However, he conveniently overlooks one important detail.
There is no excuse whatsoever to opt for active management, Kirk unequivocally states in his recent op-ed for the Financial Times, unless, as he notes, “a portfolio manager claims, ‘I have insider information, and I’m willing to go to jail to make you rich.’ In that case, you obviously just pretend you didn’t hear it and stay invested.”
Kirk explains the need for active investing to serve a purpose, stating in an explanation to Investment Officer the day after his publication, “Otherwise, it wouldn’t exist.” But what that purpose should exactly be remains completely obscure for now, according to the former head of sustainable investments at HSBC.
“Perhaps managers are the new gods in a secularized world? Maybe people prefer hope over reality, as in the gambling or lottery industry? Or perhaps elites, including the media, conspire to profit from the 80 percent who are unaware and indifferent. One thing is certain: the performance of active investors has nothing to do with it.”
Performance is random
To illustrate the “devilish track record” of active management, Kirk begins his plea in the FT with US funds, citing his ‘favourite’ argument, the annual persistence score by S&P Dow Jones Indices.
In the most recent version of the report, released in May, the authors reiterate the argument that has echoed in the academic world for decades: “Strong theoretical arguments and extensive empirical data support the assumption that most active managers generally underperform.”
While there are certainly managers who outperform the index, Kirk points out that if this truly had to do with skill, one would expect consistent outperformance. Successful managers would continue to win year after year. “Unfortunately, this was not the case. It never has been.”
The team of researchers from the S&P 500 selected the top 25 percent performing funds in the twelve months ending June 2018. Then, the analysts examined how many of those funds remained in the top quartile during the five consecutive years ending in May 2023. The result? Zero.
And what about small-cap fund managers, for example, Kirk wonders aloud. “Don’t those guys always brag about the executives they have on speed dial or the number of company visits they make?”
Even in the small-cap category, only one-third of investors belonged to the top 50 percent of managers over the past five years. This lack of sustained outperformance applies to all regions and investment categories, he concludes.
Do your homework
However, Kirk conveniently omits a subordinate clause at the beginning of the paper regarding the annual persistence score by S&P Dow Jones: “Most active managers are not all active managers, and usually is not always.”
According to Jeroen van Oerle, portfolio manager at Lombard Odier, this is a crucial caveat. “Kirk certainly has a point when it comes to global equity funds, but simply looking at the data doesn’t change the fact that there are trends that cut through market performance,” explains Van Oerle. “You just have to do your homework properly.”
Comparing with the broad market
Van Oerle believes it is not illogical for investors to compare all funds with a global index, “we do that as a fintech fund as well.” After all, an investor can track the market with an ETF for a fee of just 20 basis points. “It is perfectly valid to raise questions, but investors need to look for the ‘pockets’ of value in the market.” According to the portfolio manager, those pockets do exist.
“It’s not that my fund is interesting for investors in every market condition, but people can indeed outperform the market by activating my strategy when circumstances require it and deactivating it when everyone is fleeing from fintech.”
All investments are a choice
Moreover, Van Oerle questions whether the well-known dominant stocks will continue to grow as they have done so far. If the long-expected regime shift occurs, new leaders will dominate the market. In that case, more analysis is needed to determine the future winners, increasing the opportunities for active managers to outperform the market, potentially causing the broad index to suffer.
Van Oerle states, “If there were no reason to have actively managed funds, they wouldn’t exist. No marketing campaign can change that.”
By the way, Kirk himself indirectly engages in active investing. His ‘suspicious’ returns result from his own “active” quest for value in the market through ETFs, which he readily admits. “All investments require choices. So, I’m illogical, if not hypocritical,” says Kirk.
Nevertheless, Kirk considers selecting investments to beat the market hopelessly futile. “Good luck with choosing the portfolio managers in advance who, in turn, choose the winning companies.”
This article originally appeared on InvestmentOfficer.nl.