Data Crunch: Based on a snapshot of current returns, active managers need to up their game if they are to win back assets that have flooded into passive strategies, writes Broadridge’s Jonathan Libre
One justification for this is performance: passive strategies have ridden the longest bull market of all time and left active managers with little scope to outperform.
That bull market has now fallen victim to the Covid-19 pandemic, and while active managers could be expected to better navigate the resultant market turmoil, the initial evidence is discouraging.
If active equity managers are to use this as an opportunity to win back the allocations that have moved to passive strategies, they will need to exhibit stronger performance over the coming months
Passive strategies now represent the bulk of UK pension scheme equity assets. This is especially true for charge-cap constrained defined contribution schemes, where traditional index strategies account for 85 per cent of assets.
However, even defined benefit schemes now have a 51 per cent passive allocation within their equity portfolios. Factor-based strategies, which aim to systematically replicate active managers’ approaches at a lower cost, remain a minority solution.
Investment performance has been a key driver behind this shift. Passive investors have benefited from a sustained period of strong returns with little volatility.
Under such conditions, there is little opportunity for active managers to outperform and justify charging fees that are multiple times higher than their passive equivalents.
Coronavirus changes everything
The tragic outbreak of the Covid-19 pandemic has brought an abrupt end to that favourable investment climate.
Investors are grappling with unprecedented uncertainty over the potential scale of the economic impact and the extent to which it will be mitigated by the colossal stimulus packages pushed through by governments and monetary authorities. Pension funds, shaken by the spike in volatility, will undoubtedly be counting substantial losses in their equity portfolios.
While active strategies are not immune to crashes in asset prices, periods of heightened volatility should allow them to fare better than their passive counterparts.
Unlike passive, active managers can tilt portfolios away from stocks that are deemed the most likely to suffer in downturns and overweight those that will fare best in a recovery. On this assumption, the overwhelming allocation to passive by UK pension schemes is disadvantageous.
Actives must improve
Yet the most recent fund performance data shows little support for this argument. Across multiple fund segments, the average active manager has underperformed passive since the start of the year.
Even segments such as emerging markets, where less-efficient markets theoretically provide greater scope for alpha generation, have seen passive strategies fare better than active.
There is no doubt that some active managers continue to do well, and care should also be taken when drawing general conclusions from a simple performance analysis of fund segments that comprise a broad range of strategies.
There is also a risk of focusing heavily on short-term losses when pension fund investing is a long-term game, especially as the crisis is only a few weeks old.
However, if active equity managers are to use this as an opportunity to win back the allocations that have moved to passive strategies, they will need to exhibit stronger performance over the coming months.
Jonathan Libre is principal in the global insights team at Broadridge Financial Solutions
