If you are going to use active investment managers you may want to limit yourself to those who are both truly active and, crucially, unusually patient.
“Our results suggest that U.S. equity markets provide opportunities for longer-term active managers”
A recent study shows that funds which deviate substantially from the indices they track and which have average holding periods of more than two years perform exceptionally well, outperforming, on average, by two percentage points per year.
What’s more, that subset of actively managed portfolios was the only one to so outperform, according to the study, by Martijn Cremers of the University of Notre Dame and Ankur Pareek of Rutgers Business School.
The important distinctions here are two; how high is the “active share” of a portfolio and how long does it tend to hold its investments. Active share is a concept invented by Cremers and colleagues which measures the actual deviation a given portfolio takes from the holdings of its base index. This allows us to sort the “closet indexers” from the real active fund managers. Closet indexing is both quite widespread, due to managers wanting to minimize their own career risk, and a bit of a rip-off, as you pay for active but get something pretty close to an index fund.
The study looked at mutual funds and institutional portfolios and sorted them by both active share and average holding period.
So while frequent trading in the study was linked to underperformance, simply holding investments for longer did not lead to better performance unless it was by the sub-set of portfolios which were also taking big bets against the index.
“Our results suggest that U.S. equity markets provide opportunities for longer-term active managers, perhaps because of the limited arbitrage capital devoted to patient and active investment strategies," Cremers and Pareek write.
Read the entire article on the Reuters website.