March 29, 2018
As managing money grows tougher, the tough should stick to what works best through time: conviction. Doing robust fundamental research, thoughtfully vetting insights and having the patience to allow good ideas to become great investments. As we've seen from recent headlines, however, some active managers are better set up for this than others.
Active managers are paid to have conviction — to differentiate from the benchmark and pursue returns by distinguishing good investments from bad. It's no longer as simple as having an information advantage, which technology destroyed by giving investors instant access to the same information. Instead, conviction has to come from an analysis advantage — that decisive edge that helps investors uncover opportunities and guard against risks that aren't obvious to the rest of the market.
A true analysis advantage demands a global and long-term perspective, along with a culture that ties it all together. Many active managers can develop good ideas through robust research. But ideas are only as good as the ability to make sure they're sound and the patience to let them play out. Yet many investment managers still base compensation on shorter-term performance measures. On the other hand, having a culture that demands collaborative thinking with uncompromised information sharing and compensates team members based on long-term results, can turn an analysis advantage into a better investment outcome.
Average managers either can't build a true analysis advantage, or they don't have the discipline to allow the time for their good insights to pay off. But skilled active managers do. And the active skill they can deploy could be an investor's best defense, given the conditions we see on the horizon.
In the next 10 years, returns will be harder to come by. We also expect volatility in the markets to increase – both overall and in terms of dispersion in stock prices. In addition, we think certain markets are more richly valued and primed for a correction. This is typically when active managers shine.
In fact, a low return environment puts a premium on the ability to generate alpha. Most investors won't be able to hit their targets through benchmark returns. And nine years into the current bull market, with a pullback inevitable at some point, we think they may be taking too much risk by trying.
In market downturns, active skill could be an ally. During periods of market volatility, active managers have historically outperformed, driven by their ability to find good entry points for investment and manage downside risk. As evidence, from 1990 through 2017, the top quartile of global active managers generated 7.2% in excess returns relative to the MSCI World Index in falling market environments.1
Wherever the current market environment takes us next, one thing is certain: allocating capital won't get easier. And if investors and managers keep scouring their toolkits trying to come up with a better way to win the battle for returns, they'll always be on their back foot. Good investment decision-making relies on a process that works through time, not a shift to what could work in the moment. Conviction may be elusive for some, but for those active managers with the skill, culture and patience to build it, the opportunity to outperform is there for the taking.
The views expressed are those of the author and are subject to change at any time. These views should not be relied upon as investment advice, as securities recommendations, or as an indication of trading intent on behalf of any other MFS investment product.
1 Source: Analysis using Morningstar data. Excess returns of global equity active managers 1990–2017. Rising and falling markets based on calendar year returns when the MSCI World Index rose or fell (1990-2017). 25th percentile and median active managers taken from the Morningstar World Stock category. Excess returns, net of all fees (including 12b-1) but excluding sales charges, calculated against the MSCI World Index. Analysis covers all share class and excludes index funds. The falling markets are 1990, 1992, 2000, 2001, 2002, 2008, 2011 and 2015.
Past performance is no guarantee of future results.
This content is directed at investment professionals only.