Industry Updates

Overlooked scholarship shows managers can outperform: study

David Tuckwell

a man in a suit and tie
  • Conventional wisdom is too harsh on active managers, a new study has claimed

  • There is evidence active managers outperform after closet trackers are screened out

  • Studies deriding active managers overfocus on US large caps. Evidence of manager outperformance is stronger in places like hybrids and small caps

Active managers add value to society and conventional wisdom about them being overpaid speculators is "too negative", a new study has claimed.

Passive investing has risen relentlessly the past decade, driven by what the Nobel laureate Bill Sharpe called the "arithmetic of active management": the average actively managed dollar must perform the same as the average passively managed dollar before fees. After fees, the actively managed dollar must underperform, as it applies higher average fees to the same averaged performance.

Sharpe's arithmetic has been backed up by decades of empirical studies finding active managers underperform.

But a new study by Martin Cremers, a professor of finance at the University of Notre Dame, called 'Challenging the Conventional Wisdom on Active Management', claims the consensus on active management is too negative.

"Many funds do appear to create value for investors even after accounting for fees. While many challenges remain, we believe the conventional wisdom fails to account for the more positive findings of recent research on active manager skill," Prof Cremers found.

There are three elements to conventional wisdom that holds managers in negative light, Prof Cremers claimed:

  1. They underperform after fees, as Bill Sharpe would have it, and trading in aggregate has to be a zero-sum game as Kenneth French has argued;

  2. Evidence of persistent outperformance is weak and the distribution of star managers is consistent with chance;

  3. Skilled managers charge more, meaning any gains on skill are often lost on high fees.

Cremers acknowledges that the empirical literature is pretty damning on managers performance net of fees. But an alternative chunk of literature is more positive on the value managers add, he finds.

This alternative literature - which Prof Cremers claims uses better data and better methodology - finds persistent outperformance. It also challenges the notion that skilled managers are always more expensive.

This literature finds that almost 20% of managers can consistently outperform. It also finds that after screening out closet trackers, there is evidence that actively managed funds outperform. "Among the high active share funds, there's actually strong evidence, we argue, that there's no underperformance—perhaps even outperformance."

Limitations of the conventional wisdom come from the fact that most studies look at mutual funds and hedge funds - not things like separate accounts. They also focus on US large caps, which is the most competitive and transparent market.

"That may be the least persuasive market to consider the power of active management because the U.S. equity markets are dominated by large caps that are arguably in a very efficient, very competitive market," Cremers said. "Once you go outside U.S. large caps—you go to small caps, you go to bond funds, you go to hybrid funds, international funds, emerging markets, hedge funds—arguably those environments may be more promising."


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