Passive settings have remained integral to many investment strategies in the current tough environment. The major reason for this is the difficulty most funds and asset consultants are having in finding active managers who can substantially outperform the returns being achieved from indexing.
Frontier Investments CEO Fiona Trafford-Walker puts it succinctly when she says that in moving from indexing or enhanced indexing to an active manager, “you have to have a high level of conviction in the manager you appoint”.
Justifying her point, Trafford-Walker cites recent performance data revealing a 1.6 per cent return from indexing compared to 1.5 per cent from average active managers. “There is no proof and simply no compelling evidence to justify a major shift away from indexing,” she says.
However, the Queensland Investment Corporation’s executive general manager of international equities, Mathew Jeremy, counters that while good active managers are hard to find, they’re worth looking for. “Yes, its hard to find good active managers but not impossible and you need to cast your net very widely,” he says. “You need to look beyond names and headlines because there are some real gems out there.”
Jeremy acknowledges there’s a role for indexing in tough times but, he believes, decisions have to be based on an underlying understanding of what is actually driving markets down. Recent global events may be examples of how active managers can find it hard to make headway, but he says these circumstances are the exception rather than the rule.
Both Trafford-Walker and Jeremy Duffield, managing director of index manager, Vanguard Investments, disagree. Not surprisingly, Duffield maintains that indexing is a sound strategy in bear markets and that there’s plenty of evidence to back that contention.
“There is no sustainable evidence that active managers do any better in bear markets and the reality is that there’s only so much to go around,” he says.
Principal product engineer at State Street Global Advisers, Jonathan Shead, who was a keynote speaker at the recent Cup of Indexing seminar held in Sydney, holds a similar view.
He points to performance data which makes clear that active managers have not significantly out-performed indexed funds. While it is true that indexed portfolios can’t avoid falling markets, Shead believes the question is whether active managers can avoid falling markets. The historical evidence, he says, suggests active managers are just as much subject to the negativity of falling markets as indexed funds.
He adds that when markets turn, active managers are supposed to position for a market rebound. Yet, in two of the last three periods of market upturn, active managers have been left behind.
“Down markets are not a better environment for active managers to add value and active managers haven’t demonstrated an ability to predict market direction,” says Shead.
According to JANA Investment Advisers managing director Ken Marshman, while it’s not entirely black and white, active management is more appropriate in down markets. “When you look at it objectively, the simple fact of life is that stocks which have gone up in a bull market fall further in a down market,” he says.
Marshman says indexing does exactly what it says it does but that he believes active management is more appropriate in both down and flat markets.
Seemingly straddling the two positions is Victorian super fund, UniSuper, which in late July announced it was converting its international exposure from a purely passive mandate to an enhanced passive mandate.
UniSuper chief investment officer David St John says the move followed an analysis of both the features and potential returns available in passive and enhanced passive strategies.
However, he makes it clear that UniSuper adopts a strategic approach with respect to active or passive management and that this is evidenced in its allocations with a highly active position in Australian equities (80 per cent active) and a 60/40 split in enhanced passive and passive for its overseas equities.
St John describes this as a tailored approach which has proved highly appropriate for the fund.
Other large funds in the US, appear to be moving in the same direction. Indeed, Invesco’s head of product development at its New York structured products group, Russell Kamp, notes that in the year to end September 2002, the use by large US pension funds of enhanced strategies grew by 23 per cent. And, among those taking it up was the US’s largest public pension fund, the California Public Employees’ Retirement System or CALpers.
Kamp says: “Indexing was a wonderful place to park assets when we had double digit growth.” But after the past few years of dismal performance from equities, he believes investors will seek greater certainty of returns and greater benchmark tracking.
They will want performance surprises to be limited and they will pay fees in line with the performance generated by managers, he says.
