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 That’s the upshot of a new paper, but before you get too excited,
the implication may simply be for investors to be more or less
indifferent to the active vs. passive debate.
Unless, of course, you think you can predict bear markets, in which
case you are likely already an active investor, as well as being a
seer.
Numerous studies have indicated that active managers produce worse
returns than passive benchmarks. A new study from J. Spencer Martin
of the University of Melbourne and George J. Wang of Manchester
University computes an option-based valuation of active managers’
timing skill during bear markets added to security selection value.
This adds to evidence from earlier studies that active managers
outperform, or produce alpha, during market downturns.
“Our findings imply that professional managers, as a group, are
covering their costs rather than destroying value,” the authors
write in the study, updated in October. (http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2683360)
"We find the option-adjusted alpha is statistically
indistinguishable from zero. This finding suggests that the benefit
of the service provided by fund managers may actually fall in line
with its cost.”
That description of active fund management’s offering: “alpha is
statistically indistinguishable from zero” will not make it into
large type in many funds’ marketing materials, but the implications,
if true, are substantial.
What’s more, the data indicates that the zero alpha offering holds
good not just for active fund management in aggregate but at the
portfolio level.
Looking at fund performance from 1986 through 2010, the study finds
that active managers do better than previously thought, in part
because the value of market timing skill is higher during bear
markets, when volatility, as measured by the VIX index, is higher.
By better reflecting the option value of market timing around bear
markets, the study purports to show that active managers’ virtues
“can be large enough to compensate for other drawbacks”.
WHO BENEFITS?
Clearly the debate around active fund management performance will
continue, with many on the active side arguing that manager
selection can provide alpha, a view not backed up by this study, at
least.
The conclusion, that active management can more or less pay its own
way, isn’t earth-shattering. It does accord with the economic theory
that mutual fund managers, like actors in any other economic sphere,
will do work, in this case collecting and analyzing market
information, only up to the point where the marginal benefit meets
the marginal cost.
That view may well be correct, though there are plenty of examples
of economically irrational activity.
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Some of the implications of the study, if confirmed by further
research, could be profound.
“As such, unconditional negative alphas relative to passive
benchmarks do not necessarily imply that fund investors have
suffered significant welfare losses, or that investors do not want
to invest in those funds, or that index funds should be
overwhelmingly preferred,” the authors write.
That first idea, that fund investors suffer a loss through active
management, is both common and underlies plans to address failings
in the pension savings system in the U.S.
A rule now proposed by the U.S. Department of Labor will if enacted
force financial advisors selling retirement products and advice to
act as fiduciaries, meaning that they would be obliged to put
clients' interests above their own.
Fund analysts at Morningstar last week said that that fiduciary
standard may send $1 trillion of additional assets to passive
investment products.
That’s partly because smaller accounts will be uneconomic for
full-service advisors who tend to place clients in active products
with larger fees. That certainly was the experience in the UK, where
the passing of similar rules led to a fall in the number of advisors
and a rise in passive investment, as well as of low-cost
fund-allocation platforms.
Remove the idea that passive is better and you remove some of the
justification for those changes.
This all begs the question of why an advisor might argue for active
fund management if it was only going to produce “alpha statistically
indistinguishable from zero”. At least it keeps fund managers, who
might otherwise get on their spouses’ nerves, busy.
Being good during bear markets may not turn out to be enough.
(At the time of publication James Saft did not own any direct
investments in securities mentioned in this article. Hemay be an
owner indirectly as an investor in a fund. You canemail him at
jamessaft@jamessaft.com and find more columns at http://blogs.reuters.com/james-saft)
((jamessaft@jamessaft.com))
(Editing by James Dalgleish)
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