A presentation to:
Is Active Equity Management on
Permanent or Temporary Disability?
Atlantic Connection Conference
Tina Byles Williams, CIO and CEO
FIS Group
July 10, 2013
Philadelphia, PA | Chicago, IL | Columbus, OH
www.fisgroup.com
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Background and Key Research Questions
•
As of December 31, 2012, the S&P 500 Index more than doubled since
its March 2009 bottom.
•
Active Large Cap managers, as a class, underperformed the market
benchmark with a tenacity that is troubling leading many investors to
passive implementation of their U.S. Equity portfolios.
•
Our research evaluates the following key questions:

Are there structural factors, in either the selection methods or preferences of
institutional investors, that set them up for disappointing active manager results?

Are actively managed U.S. Large Cap strategies no longer a viable option due to
structural changes in the market? Or, are these changes cyclical in nature?

Specifically, did the positive relationship between Active Share and excess return
observed in prior academic studies change for U.S. Equity Large Cap managers in
the post-crash era, and if so, what variables led to the change?
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First Problem – Frequently Used Quantitative Metrics for
Manager Skill May Be Setting Investors Up For Failure
•
The best measures of manager skill, are both predictive and persistent.
•
Commonly used manager skill metrics, such as Alpha and Information Ratio
(Institutional Investors), and Morningstar ratings (Retail Investors) are
highly susceptible to mean reversion (i.e., the top percentile in year one has
an insignificant relationship to the top percentile over longer periods, such
as 5 years).
IR: A Good Predictor of Skill For One Year 1
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IR: A Poor Predictor of Skill For Longer Periods2
Source: FIS Group Analysis of FactSet data for period between August 31,2003 and June 30, 2008
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Second Problem: Industry Consolidation Will Likely
Lead to More Mediocre Alpha Generation
• The investment management industry has been consolidating:
•

In 1991, the top ten asset managers managed less than 21% of tax exempt assets
managed by the top 500 firms.

At year end 2012, the share managed by the top ten jumped to 44%. The top 100
managers (lowest AUM of $14.5 billion) managed 87% of tax-exempt assets.
Several independent studies suggest that scale can often decrease alpha generated by
active managers.
Sources: P&I Largest Money Managers List & Shopping for Alpha. You Get What You Don’t Pay For, Vanguard, 2011
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Measurement of Skill as Defined by Persistence of
Wins from Season to Season
•
Highly skilled activities characterized by greater dependence on individual skill and
effort. Outcome for activities dominated by luck is highly impacted by multiple
factors and other players.
•
Highly skilled activities demonstrate persistence (think of Serena Williams and
Roger Federer vs. Manuel Cabrera from Detroit Tigers who won the triple crown),
•
Highly skilled activities don’t require a large sample size (or no. of times player
plays) whereas activities dominated by luck require a large sample size to discern
skill.
•
Highly skilled activities result in a wide variance between best and worst players.
•
Highly skilled activities, limited mean reversion.
complete reversion to the mean.
Activities dominated by luck,
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Enter Active Share
•
Represents the percentage of a portfolio’s holdings which is different from its benchmark
based on a scale between 0 and 100; with 0 suggesting no difference from the holdings of the
benchmark and 100 suggesting no similarity with the benchmark.
•
Based on Yale and NYU professors Cremers and Petajisto study of 904 U.S. mutual funds’
performance between 1980 and 2003 and concluded that, on average, performance is
positively correlated with the degree of active management as measured by Active Share. 1
•
They demonstrated that funds in the highest quintile of Active Share outperformed their
benchmarks annually by 1.39%, net of fees and expenses. In contrast, non-index funds with
the lowest Active Share score underperformed their benchmark by 1.41% annually, net of fees
and expenses.
•
Active Share does not necessarily cause or connote skill; it simply measures difference from
the manager’s benchmark.
•
However, since it is directly driven by a manager’s investment policy, there is
substantial inter-temporal persistence. Maubisson’s research found a .86 correlation
among the Active Share of 1500 mutual funds between 2007 and 2012.2
•
Therefore, if a manager has skill, then Active Share amplifies both the magnitude of their
performance and the persistence through which it is expressed.
1Petajisto,
Antii and Cremers, Martijin, How Active is Your Fund Manager? A New Measure That Predicts Performance, March 2006
Michael J., The Success Equation: Untangling Skill and Luck in Business, Sports, and Investing, November 2012.
2Mauboussin,
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Active Share Which Has Historically Had a Positive Relationship With
Excess Return Generally Diminishes with AUM Growth as Portfolios
Become More Benchmark-Like
All Equity Mutual Funds for the Trailing Ten Years Ending June 30, 2012
Product Assets and Active Share
Non U.S. Equity Managers for the Trailing Ten
Years Ending June 30, 2012
Number of Portfolio Holdings
Five Years Ending December 31, 2010
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Could Studies That Purport to Show the Randomness of
Active Management Alpha Not Also Reflect These Trends?
1.
2.
3.
4.
Use of poor predictors of future performance (such as Universe rankings, Alpha and IR).
They typically don’t distinguish by AUM, but AUM can impact Active Share and performance.
They typically don’t distinguish between high and low Active Share managers (i.e., truly active vs.
closet indexers, that have historically underperformed high Active Share managers).
They may in part reflect the decline in Active Share, particularly among U.S. large cap funds:
 During the 1990s, the percentage of U.S. Equity mutual funds with high active share
dropped by over 70% and now stands at around 20%.
 1990s associated with periods of enhanced risk control/portfolio constraints, such as the
popularization of nine style box framework (large/mid/small by growth/value/core).
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Third Problem: While for Non-U.S Active and Small Cap Equity Funds, the Positive
Relationship Between Active Share, Excess Return and IR Remained, it Became
Negligible for U.S Equity Large Cap Active Funds During the Post Financial Crisis Period
Non-U.S. Active Funds for the Trailing Five Years Ending June 30, 2012
U.S. Equity Large Cap Active Funds for the Trailing Five Years Ending June 30, 2012
Source: Byles Williams, Is Active Equity Management Alpha on Permanent or Temporary Disability?, April 2013.
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Rolling Performance of Active Managers Consistent with Results of
Active Share Regressions
Rolling 12-Quarter Universe Analysis
December 31, 1992 to September 30, 2012 | Wilshire Manager Defined Universe
•
For Non-U.S. and Small Cap managers,
there is more evidence of relative
performance persistence.
•
For U.S. Equity Large Cap managers
relative performance evidences cyclicality
with each cycle averaging 5 to 6 years.
The current cycle of underperformance
began in 2009. During intense market
downturns (2001 and 2008), the
benchmark underperformed.
Sources: Wilshire Associates’ Manager Defined Separate Account Universe and Byles Williams, Is Active Equity Management Alpha on Permanent or
Temporary Disability?, April 2013.
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Factors That Primarily Impacted Active U.S. Equity Large Cap
Managers’ Relative Performance
Source: Byles Williams, Is Active Equity Management Alpha on Permanent or Temporary Disability?, April 2013 & FIS Group Model Estimates.
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Normalization of Intra-market U.S. Stock Correlations Key to
Large Cap Manager Outperformance
European and U.S. Economic Policy
Uncertainty Indices: 1/1997 to 11/2012
•
Correlation is mean reverting – anchored by the volatility of stock volatility. The primary
catalysts for mean reversion are reductions in down-market deviation and Economic
Uncertainty.
•
Globalization and the global deleveraging cycle have engendered more interconnected and
fragile economies. Although uncertainty has decreased since mid-2012, heightened
uncertainty likely to remain.
•
The relationship between Economic Uncertainty and Correlation is non-linear. Therefore,
decreases in economic policy uncertainty have a more muted impact than increases.
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Conclusion
•
The disappointing results exhibited in studies on the performance of active managers may in
part reflect poor quantitative selection criteria that are highly susceptible to mean reversion.
•
The inexorable consolidation within the asset management industry will likely lead to more
mediocre results.
•
The post-crisis period has been dominated by macro-economic variables that impaired the
performance of Large Cap managers.
•
Large Cap stocks’ greater exposure to systemic market risks made them more vulnerable to
deleterious changes in the macro-economic regime.
•
Because Small Cap and Non-U.S. managers are less exposed to systematic risks (and reflect
more non-systematic or idiosyncratic risk factors), their alpha has been more persistent through
various macro cycles.
•
The predominance of macro factors such as Correlations (that are in turn driven by Economic
Uncertainty) and monetary accommodation would suggest that their normalization could lead to
improved performance for Large Cap managers.
•
Although Economic Uncertainty has declined since mid 2012, the ongoing global deleveraging
cycle will likely prolong the normalization of the current macro regime.
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