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VIRTUAL SYMPOSIUM SERIES – SUMMARY
Surfing for Alpha while
in the Beta wave
While actively managed funds still dominate the landscape, the popularity of passive
indexing and exchange-traded funds (ETFs) has grown considerably during the lengthy
stock market rally, surpassing $4 trillion in assets in the U.S. as of the end of February,
according to Strategic Insight’s Simfund database. Clearly, passive management is
gaining momentum. But what happens if and when the beta wave ends?
A panel of investment experts from across Natixis Global Asset Management discussed
the trend toward passive management, the advantages of high active share, risk
management implications and ways to be smarter about building portfolios with active
and passive components. Below is a summary of highlights.
MODERATOR:
Leslie Walstrom, SVP
Strategic Product Marketing,
Natixis Global Asset Management
PANELISTS:
Leslie Walstrom: What do you think is driving this trend to passive strategies?
David Lafferty: There’s probably two main drivers to the momentum we’ve seen in passive
strategies. The first one is continued pressure on fees, downward pressure on fees. In the
financial advisory market, more advisors are moving to fee-based platforms and advisory
platforms, and so it’s incumbent on them to try to drive down the fees of the underlying
investments as much as possible, and that’s really driving some of the momentum. The
second thing, which shouldn’t be lost in the conversation, is that the indexes have been
Dan Hughes
Client Portfolio Manager,
Vaughan Nelson Investment Management
pretty hard to beat on the equity side recently.
Daniel Nicholas: I actually think active managers have played a role themselves. There’s a
fear of underperforming the passives out there. One thing that active managers have done is
look to diversify, to reduce the risk of underperforming a benchmark. Now, we’ve grown up
learning that diversification is a great thing and you can’t get too much of it. But we actually
think that you can get too much diversification. It actually can hurt your ability to outperform.
So investors are smart. What they’ve actually seen is that they’re getting a passive portfolio
but paying an active fee. So they’re not really getting what they bargained for.
Leslie Walstrom: This bull market just celebrated its sixth birthday. What do you think
David Lafferty, CFA®
Chief Market Strategist,
Natixis Global Asset Management
is going to happen when this market trend turns?
Dan Hughes: We’re coming through this incredible beta rally – where markets have
accelerated at a mid-teen level. And we’ve had really high correlations. But I think we are
at the top of this crest. Now we are at a period where security selection is going to begin
to matter again.
Daniel A. Nicholas, CFA®
Client Portfolio Manager,
Harris Associates L.P.
Leslie Walstrom: In market downturns, is there an advantage to having active
managers in an investor’s overall portfolio?
Dave: Generally speaking, we see a bit better returns from active managers in the downside.
But the numbers are a bit mixed. Some of the data we’ve looked at shows that many growth
managers don’t do a great job on the downside. But if you look across most of the style
boxes, value managers do tend to protect a little bit more. If you look at capture ratios or even
beta levels, it’s not surprising that value managers, relative to value benchmarks, are trying to
build in more of a cushion, so when the market falls, they often have a lower capture on the
downside, which is obviously what investors want.
Continued
Daniel Nicholas: On the downside, the risk would be that an index
we believe they’re high quality and low priced. We think that’s where
really has no soul. We think there is a place for passive investing and
the excess returns come from. We also would say that concentrating
that it’s an appreciating asset over time that will get you the upside
your portfolio is very important. The average mutual fund today has
exposure. But in a down market, give you that downside exposure.
104 stocks. We’ve built portfolios of either 20 stocks or 40 to 60
We would say that indices are really built based on market cap,
stocks. We’re going to look much different than the benchmark. And
which are based on backward-looking outperformers. You’re going
we’re going to build our portfolios regardless of what the benchmark
to get good-quality companies, bad-quality companies, overpriced
weightings say. That’s how we add our active share, our alpha.
companies, and underpriced companies, in that index. We really want
active management to take a role in finding those companies that
should fit into your portfolio in all markets. And so I think the downside
is that if we do have a market that pulls back, you are going to get that
exposure, and I just want to make sure investors know that as well.
Leslie: Shouldn’t a good active manager be index-agnostic?
Dan: Yeah, I would say we are relatively benchmark-agnostic. If you
look at the way that we construct our portfolios, we have very loose
limitations around sector or security weights. This is done by design.
Leslie: Does active share apply to fixed-income?
You need to be able to construct a portfolio that is both different in
security and in security weight than an index. We compare ourselves
Dave: The term active share doesn’t really work for fixed-income.
to an index because our investors like to compare our portfolios against
In the equity market, there’s a difference between stock holdings.
something. But the benchmark doesn’t change our investment thesis,
In the bond market, it’s not really the same because the index might
it doesn’t change our target return objective, it doesn’t change our
have two names that are very similar – the same issuer, maybe the
portfolio construction and our process.
same coupon, maybe the same yield, but the maturity dates are
slightly different. So the idea of active share doesn’t mean the same
thing in fixed-income portfolios.
Leslie: Are there other attributes of active management that
offer an edge in beating the benchmark?
Dave: Let me start by saying benchmarks have no risk management
Leslie: Let’s delve a little deeper into the attributes of a good
soul. Whether it was the tech and telecom bust in 2000 through 2002
active manager. I’ve heard quite a bit about the role of active
or the great financial crisis in ’08 and ’09, investors have been through
share. Dave, can you start by defining active share?
some really painful times. Natixis has done global investor surveys
and we know how much investors really want their managers to focus
Dave: Active share is a very simple measure. It simply asks the
on downside protection and downside risk management. Well, by
question, how different is my portfolio from the benchmark? You
definition, you don’t get that when you invest in an index. If the
simply look at everything in a manager’s portfolio – by weight and
market goes down and you own the market, you go down as much
by name, everything that overlaps the index is their passive share.
by definition. So there are a lot of different ways managers can
Everything else in the portfolio is their active share. So if you take
sort of mitigate the volatility of the risk in a portfolio, but that’s really
their active plus their passive, you get to 100% of the portfolio.
a manager-by-manager conversation. But time horizon and that
So if investors are paying active fees, they should make sure that
active share is as high as you can get it to be.
Dan: We entirely agree with Dave. The way we end up deriving our
active share, which we strive to be north of 90, is really an output of
our process. We do look at the world a little bit differently, and I think
you have to in order to enable yourself the opportunity to deliver a
high active share to your investors. We start with a target return
objective. We don’t look to outpace an arbitrary benchmark by a certain
number of basis points on any calendar year. We also look for very
specific criteria, and really only invest in three types of companies:
a company that we’ll describe as an undervalued growth company;
an undervalued asset company, where there is a gap in valuation and
potential to manage downside are really two legs up that good
managers should have over an index in the long run.
Daniel: Really risk or volatility is opportunity for us. Especially with
the advent of passive investing, more and more stocks are trading
on technicalities. We’re fundamental investors who look to find
businesses that are trading at a significant discount to what their
businesses once were. What we’re going to try to do is buy these
companies at 60 cents on the dollar and own them over a long time
horizon of typically three to five years, and sell them at 90 cents on
the dollar. The beauty of this process is it limits our downside. But we
believe it also gives our portfolios the best opportunity to outperform
over the long term, because it’s always forward-looking.
an identifiable catalyst to help close that gap; and the third place we
think can deliver that type of return expectation is in what we describe
as undervalued dividends.
Daniel: Active share is a byproduct of our process, as well. What we’re
doing is exclusively building portfolios of our high-conviction names –
names that have the best risk/rewards that we can find out there. So
Leslie: When it comes to tax efficiency, do passive managers
have a big advantage over active managers?
Daniel: While tax-efficient investing is not a primary component of our
investment strategy, we do manage taxes within our portfolio. If you
think of a doughnut and the doughnut hole is the taxes, we’re trying
to minimize that doughnut hole, but not reduce the overall size of the
Dan: Regarding cost-effectiveness, no longer do you need to own five
opportunity of the doughnut, so to speak. So what we’re going to do
large-cap managers that all own 100 names. When you look at it in
is look at our tax lots. We have core positions that we tend to hold
reality, they don’t own 500 unique names, they probably own 20.
three to five years and we can trade around those positions. So when
And you just bought some really expensive beta, right? It makes far
a tax lot is down maybe 20%, we can trim some of that position, wait
more sense to go and buy inexpensive beta for a couple of basis
31 days, and add back to that position. We’ll also wait until a position
points and then go out and satellite and outsource to high active share
is long-term.
managers for those excess returns.
Dave: There are lots of ways that active managers can bring down that
Dave: Many people think that if you’re an active manager and you
tax liability. So we hear it often said that indexes are super tax-efficient,
believe in active share, you’re somehow against passive indexing.
and the implication is that active managers are not. There are lots of
That’s sort of a false argument. We’re not against passive indexing,
good active managers who are very tax-efficient.
we’re against closet indexing. So when managers like my colleagues
here go out and talk about their high active share, it’s really trying to
Leslie: Is there a place for both active and passive in investors’
portfolios?
Daniel: Absolutely, and we’ve heard from more and more sophisticated
investors that we’re dealing with on a daily basis. They call it the core/
satellite portfolio construction process. So they’re able to get their beta
for a low fee using indices or ETFs – that lowers the overall fee. Then
they’re able to add on active managers on top of that to provide the
take assets from managers who are sort of pretending to be active.
There are several reasons why investors would put their money in
passive. The fee efficiency argument is one. There’s another one we
see which is around liquidity and transitioning. Passive investments,
because of their liquidity, can be a great way to maintain that beta
exposure while you’re looking to replace an underperforming active
manager. So they can be a great complement. n
alpha. So we’re seeing a confluence of that, and we would agree with
that process. What we’re trying to do is provide a portfolio that
is sufficiently active to basically reactivate your ability to outperform
the benchmark.
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This material is provided for informational purposes only and should not be construed as investment advice. The analyses and opinions referenced herein represent the subjective views of
the speaker(s) as of March 24, 2015. They are subject to change at any time based on market and other conditions. There can be no assurance that developments will transpire as forecasted.
Actual results may vary.
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Active share: Measures the proportion of a portfolio’s holdings (by security weights) that are different from its benchmark. A higher active share indicates a larger difference between the
benchmark and the portfolio.
Alpha: A measure of the difference between a portfolio’s actual returns and its expected performance, given its level of systematic market risk. A positive alpha indicates outperformance and
negative alpha indicates underperformance relative to the portfolio’s level of systematic risk.
Beta: Measures the volatility of a security or a portfolio in comparison to the market as a whole.
Beta wave: Beta wave refers to the lengthy U.S. stock market rally that began in 2009 and has continued through the first quarter of 2014.
Bull market: A market characterized by rising security prices.
Capture ratio: A measure of an investment’s performance relative to its benchmark.
Downside capture: A measure of an investment’s performance in down markets relative to its benchmark.
Excess return: The percentage of return over the return of the relative benchmark.
Exchange-Traded Funds: An exchange-traded fund (ETF) is a type of fund that tracks an index, commodity or basket of assets and trades on an exchange.
Volatility: The range of variation in the value of a security.
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