Is there a future for active fund management?
Analysing current trends
Shrey Srivastava, London 06.05.19
LSE SE Business and Finance Guild, London School of Economics
In the past few years, active hedge fund management (whereby specific investments are made with the aim of beating the market has seen a significant decline in popularity.) This can be seen by the fact that passive managers (whose investments track common stock indices such as the Dow Jones 30 or the FTSE 100) now occupy over a third of the US market for mutual funds (FT, 2016). A significant driver of this has been a growing realisation by investors that the performance of active fund managers in many cases does not justify the fees these managers charge for their services. For example, in analysis of pension schemes over the past quarter of a century, it was found that active managers beat the market (i.e. major stock indices) for only 16p per £100 invested with them (FT, 2018). With an article on the Financial Times asking the question “The end of active investing?” (FT, 2017), it’s clear that it is easy to have a bleak outlook for the industry going forward. But how justified really is this view?
Taking a theoretical perspective, although there is no denying that many active strategies have not generated significant alpha (above market returns) in the past, it does not mean that all strategies have the same issue. Looking at the legendary thesis of “value investing” employed by Benjamin Graham and his disciple Warren Buffett, it remains clear from the huge alpha they have generated (Costa, 2012) that the strategy of looking for stocks with low price relative to their intrinsic value has its merits. Doing this, of course, is another matter, but the fact remains that it is possible. This forms the base of my thesis: although the active fund management industry may shrink as a whole we are going to see a shift towards increasing consolidation of funds in the hands of larger asset managers with higher alpha generation capabilities. Already many active asset managers are slashing fees in the face of passive competition (Collinson, 2017) which would suggest that the more well capitalised will be far better equipped to survive in this era.
More so, the strategies active asset managers employ are also changing with the times. The advent of technology and machine learning has led to the rise of so-called “quantamental” investing (Watts, 2018) whereby quantitative stock screens are combined with balance sheets and qualitative analysis. These strategies may have the potential to revive active investing once more, as the spectrum of strategies is now broadened so much. This is especially true given that some of these strategies seem to have the potential to generate significant alpha in the future. As an example, one quantamental strategy beat the S&P 500 in 23 of the past 30 years (Watts, 2018). While of course backtesting is far different to real-time investment, combining the best elements of two different investment theses even in theory has significant advantages.
To conclude, it is clear that the rise of cheaper passive funds has the potential to shrink the active fund management industry. In fact, it already has. However, the fundamental conclusion of this article is that although we may see some shrinkage, the active management industry will see consolidation and find new and innovative ways to generate alpha. These include strategies such as “quantamental investing” which, in my opinion, will only become more prominent in the future as technologies like machine learning continue to advance.
Collective Equity Ownership Ltd. (CEO) is a secondary fund. We allow founders and shareholders of VC-backed companies to pool together their shares with other late-stage companies to diversify their portfolio.
If you know any cool founders, or someone with a lot of VC experience, get in touch! We love meeting new people!
Other Viewers have also read: