The active versus passive investment argument has been one of the hottest debates in the investment management space over the past few years. Many observers, myself included, believed 2017 would be a stock picker’s year, due to an increase in market volatility.
Market volatility, measured by CBOE’s VIX index, started to decline at the end of 2016, which was surprising, given the uncertainty surrounding fiscal policy. This uncertainty led me to believe that volatility would increase during 2017, but as you can see in figure 1, I am not clairvoyant and the VIX index hit all-time lows throughout the year. Another factor contributing to my beginning of the year prediction, was the low correlations amongst the 50 largest S&P 500 stocks, which presents opportunities for stock pickers.
Figure 1 - Source CBOE
With 2017 in the rear view mirror, we look back to determine if active managers outperformed, and if so, which asset classes provided opportunities for financial advisors to find outperformance.
Focusing on the different PSN universes, we can see the percentage of managers who outperformed the appropriate benchmark for each major universe. Historically, efficient asset classes such as large cap equities and investment-grade fixed income have favored passive investments, compared to less efficient asset classes such as small cap equities and emerging markets.
In Figure 2, we take a closer look at the nine broad PSN domestic equity universes. As one can expect, the less efficient, PSN Small Cap Value universe offered numerous opportunities to find outperforming strategies, as 74% of the strategies within the universe beat the Russell 2000 Value index. Financial advisors were also able to find a high percentage of outperforming managers in the PSN Large Cap Value universe, which is traditionally viewed as an efficient asset class, as 86% of the strategies outperformed the Russell 1000 Value index. There were only two universes where the index ranked in the top 50th percentile – PSN large cap growth (38%) and PSN mid cap core (46%).
Figure 2 - Source: Zephyr StyleADVISOR – As of December 2017
Historically, foreign equities have been a good place to look for outperforming active managers, as those asset classes are less efficient, and that continued through 2017. The MSCI Emerging Markets Index and MSCI World Index were the only indexes to rank in the top half of their respective universe of managers (45th and 46th percentile, respectively). Active managers fared well in the other nine foreign universes, as a high percentage of active strategies outperformed their respective benchmark (figure 3).
Figure 3 - Source: Zephyr StyleADVISOR - As of December 2017
Like foreign equities, foreign fixed income strategies outperformed their benchmarks, as 84% of the strategies that make up the PSN International Emerging Markets Debt universe beat the BofA Merrill Lynch US Dollar Emerging Markets Sovereign Plus index. On the flip side, municipal strategies didn’t offer many opportunities, as only 12% of active strategies outperformed the Bloomberg Barclays Municipal index.
When looking at the 25 universes used in this study, there were only seven where the index ranked in the top 50th percentile, while the other 18 universes experienced a high percentage of managers who outperformed the index. When you take a closer look, some of the historically efficient asset classes, such as, U.S. large cap value, U.S. large cap core, and international large cap core provided opportunities for financial advisors to locate outperforming active managers.
Even though 2017 was void of volatility, which typically benefits stock pickers, active-managed strategies have fared well compared to their respective benchmark. There will continue to be benefits to passive investing, however, if active managers string together more years like 2017, they might be able to stem the flow of assets into passive investments.
Ryan Nauman is a VP, Product and Market Strategist at Informa Financial Intelligence.