How to pick assets for active management

Given the merits and pitfalls involved in selecting an active manager, trustees should be selective when making active management decisions to ensure they receive the best return from every unit of risk taken. 

We believe active managers will generate added value over time

We believe it is worth considering the merits of active management but would urge trustees to invest appropriate time and resources to successfully select an active manager where it is likely to be of most benefit to the performance of the assets of their schemes.

Academic research suggests that efficient markets such as those of government bonds and developed market equities do not typically lend themselves to successful active management. 

That is not to say that it is not possible for a highly skilled manager to consistently outperform an index of an efficient market, but due to the readily available information within such markets it is more challenging for a manager to separate itself consistently from the peer group. 

That said, there are numerous examples of successful managers within these developed asset classes who have continually managed to beat their benchmarks.

These are due to two reasons: markets are not as efficient through time as academic research suggests, or managers are taking more risk. Both possibilities are highly pertinent when selecting an active manager.

Market inefficiency

Markets that are categorised as less efficient are typically suggested as areas where users of active management can benefit.

Asset classes such as emerging market equity and debt, hedge funds and property, amongst others, all generate a wider dispersion of relative returns than typically seen in the spectrum of returns generated by managers investing in more efficient or developed markets. 

Given the inefficiencies within these asset classes, active management can add significantly to overall returns achieved by investors, provided they can successfully select a manager who consistently outperforms. 

Further, there are an increasing number of asset classes considered by pension funds over recent years that do not necessarily have an obvious benchmark – or the investment opportunity is less known. 

Pioneering funds investing into such asset classes present significant opportunities for pension funds, but investing in them does not come without risk. Given the nature of such markets it is often impossible to gain exposure without embracing active management.

For example, many multi-asset alternative, private equity or infrastructure funds will not have a benchmark that one can assess performance against in the conventional sense. 

No guarantees

Active management is of course not a guarantee to increased returns. In the traditional sense, a manager taking an active management decision is positioning his portfolio away from that of an index to achieve a better return where it deems opportunities to be available. This can lead to underperformance against a peer group. 

The question is often asked where it makes sense to invest in an active strategy and where it would be safer sticking to passive strategies. The answer is very much dependent on the scheme's approach to risk. 

We would encourage schemes to consider the merits of active management for all asset classes. However, we recognise that for many reasons, including amongst others governance budgets, many schemes are more comfortable adopting a mix of active and passive strategies. 

We believe active managers will generate added value. Naturally, there will be times when markets behave in a manner which makes short or even medium-term outperformance difficult, but over time we believe there exists the opportunity for skilful active managers to outperform. 

Trustees should examine what is a good fit for them in terms of where they want to incorporate active risk into their portfolios to ensure they are not missing any opportunities to increase overall scheme returns. 

Working together with skilled experienced investment consultants, with expertise in selecting high quality fund managers, has added and should continue to add value to pension schemes.

Ciaran Mulligan is global of head of manager research at Buck Global Investment Advisors