he active manager remains a thriving species in the UK. 76% of AUM is in active funds, 20% in passives, while only 3% is in enhanced index or smart beta funds.
It is curious how resilient active equity managers have been in the face of seemingly damning statistics. For example, actively managed UK equity funds routinely fail to beat benchmarks, with 75% underperforming over the past decade.
However, even the active managers beating benchmarks may still not be justifying fees. Smart beta offers cheap, simple exposure to factors such as value, momentum, quality and low volatility, in an attempt to improve on market-cap weighted benchmarks. These systematic, factor-tilted strategies now mirror what the majority of active equity managers, either deliberately or not, employ to generate alpha. Fund selectors can now place active returns in a better context. Under this lens, the return profile of most active managers is likely to be diminished.
The bottom line is active equity fund managers, with higher charges, should be able to beat benchmarks and the relevant smart beta strategy – otherwise what is the point? But is there a place for active equity managers at all? As competition has increased, we have seen the evolution of the ‘true alpha’ manager. This is a fundamental manager who understands the factors and the anomalies they are exploiting and has a process offering more. A ‘true alpha’ manager can offer a differentiated approach still rooted in an empiricallybacked style, but allows for the creation of a higher conviction portfolio of 30-50 ideas. Smart beta approaches cannot build concentrated portfolios.
While fundamental managers come at an increased cost, they should be evaluated in the context of potential superior returns. Institutional investors, in particular, may find the marginal extra cost is outweighed by the potential for true alpha. True alpha is rare; we can screen out most strategies. If investors are paying active fees, managers must offer more than the alternative. It is time to focus on managers capable of delivering returns worth paying for. The others face extinction.