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Original Research & Thought Leadership

Rigorous, data-driven research is the foundation for the Council’s efforts to balance the narrative on active and passive investment management. Since 2018, the Council has sponsored research, developed thought leadership and hosted educational events to serve as a resource for investors and policymakers seeking to learn more.

A diverse team of Council members representing different viewpoints, business models and investor types oversees our research process. Collectively, this team has produced a growing library of commentaries and insights on active management designed to help investors make informed decisions for investment planning and portfolio construction.

Highlighted here are seven substantial pieces of academic and original Council research followed by selected insights curated from leading investment firms and academics from across the industry debunking myths, exploring active management’s vital importance to the securities markets and examining the essential role of active management in ESG and sustainable investing.

Council Academic Research

This research was supported by the Active Managers Council. Download requires membership, subscription, or fee.

Challenging the Conventional Wisdom on Active Management

K.J. Martijn Cremers, Jon A. Fulkerson, Timothy Brandon Riley
Financial Analysts Journal | July 18, 2019 | Volume 75, Issue 4

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Active Investing and the Efficiency of Security Markets

Russ Wermers
Journal of Investment Management | January 2021 | Volume 19, No. 1
Winner of the 2021 Harry M. Markowitz Special Distinction Award from the Journal of Investment Management and New Frontier Advisors

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“Our review of the most recent literature suggests that the conventional wisdom is too negative on the value of active management,” write Cremers, Fulkerson, and Riley (2019).

This academic paper is a broad review of the past 20 years of research on active management.  The paper argues that contrary to the current consensus, “active managers have a variety of skills and, in many cases, tend to make value-added decisions. In other words, many funds do appear to create value for investors even after accounting for fees.” The authors identify specific ways active managers add value, including anticipating changes in market volatility, using information effectively, corporate oversight, and tax management.

A practical takeaway from the paper is that traditional approaches to selecting active managers – which consider past performance, investment approach, manager characteristics and the investment environment – have validity because they can identify skill in advance.

“All investors, both active and passive—as well as the real economy—benefit from the efforts and cost expenditures of active managers” writes Professor Russ Wermers of the University of Maryland’s Robert H. Smith School of Business

In this paper, Wermers focuses on a critical contributor to market efficiency: the activities of active investment managers. He describes the mechanisms that translate active managers’ activities into market efficiency. Specifically:

  • Active managers correct market anomalies.
  • Active managers provide liquidity.
  • Active managers incorporate information into market prices.
  • Active managers monitor corporate management.

In sum, concludes Wermers, “the average ‘alpha’ provided by active managers … does not adequately capture the value of the active management industry to capital markets.” The total value-added that active managers generate for society as a whole is significantly higher than the value of the benefits that they provide to their own investors.

Council Publications

A More Balanced Narrative: Broadening the Discussion on Active Management

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Rethinking Survivorship Bias in Active/Passive Comparisons

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Sustainable Investing
is an Active Process

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A More Balanced Narrative: Setting the Record Straight on Active Management

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“Active and passive strategies can happily coexist,” writes author Dave Lafferty. “Only when investors abandon the false dichotomy that one is good, the other bad, will they be able to build more optimal portfolios.”

The tug of war between active and passive investment strategies has grown increasingly one-sided in recent years. This paper presents a more balanced discussion of the factors that drive relative performance between active and passive investing, examines the methodologies for comparing the two approaches, and argues that passive investing is raising the bar for active managers. It counters the oversimplified conventional wisdom that all passive is good and active is bad. In so doing, it illustrates a much more nuanced understanding of the pros and cons of both active and passive investing styles and how each can play a role in investors’ portfolios.

“Studies of actively-managed funds that incorporate survivorship bias adjustments may need to reconsider their methodologies if they are to make an accurate assessment of manager skill.”

In this article, we take a close look at the survivorship bias adjustment in one of the most visible comparators of active and passive fund performance — Morningstar’s Active/Passive Barometer — and examine how that adjustment is affecting perceptions of the value of active management. We discuss passive fund survivorship rates and how they might be incorporated in survivorship bias calculations. We conclude with observations regarding the limitations of survivorship bias adjustments, especially when evaluating performance over long periods. In sum, investors should not rely on the popular “scorecards” for active and passive management – at a minimum, they should be taken with a big grain of salt.

Readers may also be interested in Persistence Scorecard Doesn’t Predict Investor Success, a related piece that similar exposes flaws in the methodology behind the S&P Persistence Scorecards.

“The central insight of this paper is that sustainable investing inherently involves active decision-making.”

The traditional actively managed sustainable investing takes a dynamic approach to the assessment of materiality, thinks broadly about how those factors affect specific companies, and engages with corporate managements around their efforts to address sustainability risks. Active and index-based managers alike assess both the importance of sustainability issues and how firms are managing the risk posed by these issues. However, active and index-based managers have very different approaches to making those assessments. The active approach to sustainable investing focuses on:

  • A tailored assessment of individual investments.
  • A future-focused evaluation of an investment’s long-term risk and opportunity.
  • A holistic approach to assessing portfolio risk management.
  • A long-term commitment to stewardship.
  • Integration with investor goals.

In sum, the active approach allows for a more nuanced consideration of a wider range of quantitative and qualitative factors, which helps investors tailor their portfolios to their sustainability goals.

“Overall, the works discussed [in this paper]. . . . suggest a new conventional wisdom: that active and passive both add value for investors in different ways and that active investing is essential to the health of the markets.”

As a follow up to A More Balanced Narrative (2019), this paper examines more recent thinking on active summarizing themes on active and passive investing, including:

  • Reassessments of the conventional wisdom regarding active management
  • The role of active management in sustainable investing
  • Revisions to approaches to measuring investment success
  • A new awareness of the active aspects of all investing
  • The centrality of active management in maintaining market efficiency

Overall, the studies discussed in this paper present a more balanced narrative about the value of active management.

Active Management and
Market Efficiency

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“Given the important role that efficient markets play in developed economies, the academic literature provides ample evidence of the critical part played by active management in economic growth and capital formation.”

This paper reviews the empirical evidence on trends in market efficiency in the United States and the role that active management plays in creating market efficiency.

Active management is the driver of market efficiency. Active managers perform research on issuers, analyze assets underlying securities and assess values. Through the buying and selling process, active managers establish the market prices for securities. By contrast, passive managers are usually “price takers” rather than “price makers.” Therefore, in the broadest terms, an increase in the amount of active management will lead to greater market efficiency, while an increase in passive management will reduce market efficiency.

A body of academic literature studies how the increase in passively-managed assets – and the concomitant decrease in actively-managed assets – has affected market efficiency. Taken together, these studies suggest that: pricing efficiency has declined, return comovement has increased, securities prices are more volatile, liquidity has decreased and liquidity exhibits greater comovement.

Selected Insights

Hedge Fund Performance: End of an Era
Nicolas P.B. Bollen, Juha Joenvaara, Mikko Kauppila / Financial Analysts Journal
This academic research identifies prediction models that can select hedge funds which subsequently outperform.

 

Selecting, Evaluating, and Monitoring Investments in DC Plans: A Legal Perspective
Alison V. Douglass, Christina Hennecken / Goodwin Proctor LLP / 2021
“It’s about the process.” This legal brief provides three key takeaways for plan fiduciaries.

 

ESG Rating Disagreement and Stock Returns
Rajna Gibson, Philipp Krueger, Nadine Riand, Pater S. Schmidt / Financial Analysts Journal
This academic research found that the average pairwise correlation between ratings of seven different providers was just o.45.

 

2021 Global Institutional Investor Outlook | Into the great wide open
Dave Goodsell / Natixis Investment Management / 2021
“Active management takes a front seat in portfolio plans.” The 2021 edition of this annual survey provides insights on how institutional investors view active management today.

Back to Reality: The Important Role of Active Management in Defined Contribution Plans
Jonathan Barry, Jessica Sciafani, Ravi Venkataraman / MFS / 2020
“We believe that skilled active management will be critical to helping plan sponsors and participants sort through these complex issues as they drive toward successful retirement outcomes.” This MFS white paper addresses five common misconceptions around the use of active management in defined contribution plans.

 

Divergent ESG Ratings
Elroy Dimson, Paul Marsh Dimson, Mike Staunton / Journal of Portfolio Management
This academic research examines the ESG ratings from three providers for six large companies and finds “minimal correlation” and even disagreement on factual issues.

Aggregate Confusion: The Divergence of ESG Ratings
Florian Berg, Julian F. Koelbel, Robert Rigobon
This academic research calculated that 53% of the discrepancies in five sets of ratings “comes from the fact that the rating agencies are measuring the same categories differently,” while 47% “stems from aggregating common data using different rules.” They argue that their results suggest that “different sustainability ratings cannot be made congruent simply by taking into account scope and weight differences.”

 

On Board With a Long-Term View
Carol W. Geremia, Robin A. Stelmach / MFS / 2019
“The resulting misalignment between principals and agents – asset owners, boards, advisors, consultants and their investment managers – can lead to a lack of trust and create inappropriate incentives and poor decision-making by all parties.” This MFS case study discusses how boards can better align the conversation on performance metrics.

 

Looking for Easy Games in Bonds
Michael J. Mauboussin / BlueMountain Investment Research
“Mimicking indexes in bonds is not as straightforward as it is in stocks.” In this paper, Michael Mauboussin explains why.

 

Passive in Name Only: Delegated Management and “Index” Investing
Adriana Robertson / Yale Journal on Regulation /2018
This academic research analyzed more than 900 indexes and found “substantial heterogeneity across indices.”

The (Mis)Uses of the S&P 500
Adriana Robertson
This academic research concludes that, while the S&P is seen as a passive benchmark, its composition changes “substantially over time” and is “not ‘neutral’ or ‘universal’ in any meaningful sense.”

Abusing ETFs
Utpal Bhattacharya, Benjamin Loos, Steffen Meyer, Andreas Hackethal / Review of Finance
This academic research examined individual investor trading at a large German brokerage firm and found that portfolio performance did not improve as a result of buying ETFs.

 

Debunking the High Yield Index and High Yield ETFs
John McClain, Bill Zox / Diamond Hill Capital Management / 2017
“There are meaningful differences between equity and high yield index construction and passive alternatives.” This 2017 white paper explains why investors need to understand the intricacies of passive management in high yield fixed income.

Measuring Skill in the Mutual Fund Industry
Jonathan B. Berk, Jules H. van Binsbergen / Journal of Financial Economics
This academic research presents an alternative to the “success rates” that are commonly used to measure the success of actively managed mutual funds.

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