Tuesday, 30 October 2012 - 20:00

 

Charts

Does Active Management Outperform

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We have recently compiled a brief overview on the Seed Absolute Return Fund, taking a look at the strategies implemented in the fund, who should invest in this fund and why. Click here to go to Seed's Articles and Research and feel free download the review and some of our fund fact sheets.

Many research papers and countless reports have been commissioned to investigate whether active managers outperform the market, especially once costs are taken into account. The emphatic response is that managers (in general) don’t outperform the market. While this is generally true, any purely passive strategy will also underperform the market as there are always costs involved in managing any strategy.

Most studies focus on a single period when comparing the performance of a fund or a group of funds versus the market. This approach is disingenuous as, while there are periods of both out and under performance for active managers, the period chosen is typically altered to match the desired outcome – i.e. the chart is fitted to the data! The 2 charts below show how two different conclusions can be reached on the South African market.

Chart 1: 10 Year Performance of the ALSI vs the Average Value Equity Manager and the Average General Equity Manager

Chart 2: 3 Year Performance of the ALSI vs the Average Value Equity Manager and the Average General Equity Manager

Chart 1 indicates that over the past 10 years active managers (Value and General Equity) have managed to outperform the market (ALSI) after taking into account all costs involved in managing the funds. Over a shorter period (3 years in chart 2) the ALSI has been able to beat both category averages. There will naturally be a bit of survivorship in both data sets, but the evidence is there that if you do your homework and choose a good manager there is the potential to outperform the market over the long term.

The above analysis is highly dependent on the starting point, and as such can be changed to suit the needs of the argument. At Seed we therefore look at rolling performance to get a better idea of what has been achieved over different periods. A comparison over rolling periods removes a large element of starting point bias.

Chart 3: Rolling 12 Month Performance of the ALSI vs Rolling 12 month Alpha of the Average General Equity Manager

Chart 3 above clearly shows that local managers do best when the market delivers low (or negative) nominal returns, as it is in this environment that stock selection skills are more important. Manager performance is cyclical, and determining the market environment going forward plays a role in the selection of the managers within the Seed Funds.

In previous reports we have discussed how smart beta investing (investing into passive strategies that are, by design, different to the index and are able to outperform) can form part of an investor’s toolbox. We are agnostic when it comes to deciding between active and passive investment vehicles and focus purely on those investments/strategies that have the greatest chance of delivering market beating returns after all costs have been levied.

We therefore typically construct our Funds with a combination of smart beta AND active managers. In this way we attempt to extract the best of both worlds.

Take care,

Mike Browne

www.seedinvestments.co.za
info@seedinvestments.co.za
021 914 4966

Tue, 30 Oct 2012

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