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Does active management pay off?

12 novembre 2019

In Sweden and Norway, for example, fund investors are complaining that they have been paying for services they have not received. This has also been picked up by the international finance press.

Fund investors believe that despite paying for active management – whereby the fund manager aims to outperform a certain benchmark index over time – they have instead been paying for units in funds structured in essentially the same way as the index, which are by definition incapable of outperforming the market. Since active management is more expensive than index management, they believe that they have been overcharged.

Actively managed funds have a high active share

Active management does not mean that managers buy and sell their holdings frequently. What it does mean is that managers conduct their own analysis, as opposed to passive index managers who base their fund selection on a given template, namely that the fund portfolio should reflect the stock market index.

How, then, can fund investors find out whether a specific fund is actively managed? One way is to look at the fund's active share. Active share is an indication of the extent to which a fund's holdings overlap with its benchmark index. If the fund's portfolio is identical to that of its index, the active share is 0. If no holdings in a fund are included in the index, the active share is deemed to be 100. A fund with low active share will in reality invest in a way that roughly reflects the market in general. This means that it will most likely be nigh on impossible to beat the market over time.

Truly active management may pay off

The question many people are asking is whether it is worth investing in actively managed equity funds or whether they are better off investing in cheaper index funds. Although this debate has been raging for some time, the arguments remain unbalanced. Active management is often directly compared with passive management.

Studies conducted by the fund research company, Morningstar, show that it does indeed matter how actively a fund is managed, as measured by active share. The higher the active share, the higher the return. Global equity funds with an active share in excess of 90 percent, for example, have delivered excess returns of more than 1 percentage point relative to the benchmark index, after fees, in the period under review.

How active are SKAGEN's funds?

SKAGEN's equity funds are marketed as actively managed funds. They all have an average active share in excess of 90 percent[1].

Active management means that the fund will not follow the performance of the index; it may from time to time either outperform or fall behind the index. Active management in general has faced challenges in recent years, something that has affected both SKAGEN and other fund managers. There are several reasons why active managers have struggled. For example, there have been periods of highly correlated returns; many stocks have increased in value while fluctuations have been low, and this has had an adverse effect on active managers. Widespread Quantitative Easing has been another factor; the availability of relatively cheap money has inflated stock markets generally and equities been driven more by momentum than company fundamentals.    

Large companies have become more expensive

The current low interest rate climate has attracted an increasing number of investors to the stock market. These have primarily invested in the most popular companies that hold the most weight in the index. Many have invested in various types of index and ETF funds which have become very popular in recent years. This has benefited large, already popular companies while active managers such as SKAGEN, whose investment philosophy is based on investing in undervalued, under-researched and unpopular companies that have potential for upward valuation adjustment, have been disadvantaged.

Closet index fund managers

Many people believe that equity funds with an active share of less than 60 percent should not be considered active. These funds, which still claim to be active, are often referred to as closet index funds. Closet indexing is common in many countries.

In the study "Indexing and Active Management: International Evidence", researchers have assessed this situation in a number of countries. The study shows that closet indexers are most common in Sweden where 56 percent of Swedish funds are considered to be closet index funds. At the other end of the spectrum is the US where only 15 percent of fund managers are considered closet indexers. Between these two extremes are a number of European countries where closet indexers account for around 30 percent of fund managers.

[1] Active Share figures based on 2010-2019 for SKAGEN Global, SKAGEN Kon-Tiki and SKAGEN Vekst; 2012-2019 for SKAGEN m2; 2015-2019 for SKAGEN Focus; 2017-2019 for SKAGEN Insight

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