Asset managers: outperformance vs goal meeting
Should asset managers use outperformance-based strategies, or a more passive approach? Marriott says neither – they could have more tooffer.
Active and passive management
Today’s obsession with notions of ‘outperforming’ has resulted in asset managers losing sight of their clients’ needs. By pursuing a strategy aimed at helping investors to realise their goals, as opposed to remaining anchored to the generic and tired strategy of ‘beating the market’, active asset managers have a meaningful role to play. The key is to align the experience and expertise of investment professionals with the needs of investors and to charge a reasonable fee for this service. Active management refers to a portfolio management strategy where the manager makes specific investments with the goal of outperforming a benchmark typically referred to as ‘beating the market’. The opposite of active management is called passive management, better known as ‘indexing’ or ‘tracking’. The primary benefit of passive management is low fees and guaranteed market performance as opposed to the primary benefit of active management being the promise of ‘outperformance’.
Asset managers locally and abroad
Over the years, active management has come to dominate the South African market, with investors willing to pay more for the hope of superior returns. Unfortunately, however, there is mounting evidence suggesting that the pursuit of outperformance is an endeavour where the probability of success is far too low for asset managers and investors alike.
In the US, even before fees, beating the market is still difficult. Charles D. Ellis, a consultant to large institutional investors, discussed the challenge that the profession faces in a 2011 article in the Financial Analysts Journal called ‘The Winner’s Game’. He noted that, “Most investors are not beating the market; the market is beating them…and it’s much, much harder to beat the market after costs and fees.” Ellis found that the percentage of mutual fund managers who lag their relative index, after fees, is 60% in any one year, 70% over 10 years and 80% over 20 years.
Active management on the slump
Locally, the picture looks very similar. There are currently 108 domestic general equity funds with five-year performance track records. It would be reasonable to assume that, over this period, the primary objective of the majority of these funds was to outperform the All Share Index. However, an analysis of the funds’ returns reveals that only 20% managed to achieve this goal. The statistics are even worse for active property fund managers. Over the past five years only one actively-managed property fund has been able to outperform the South Africa Property Index.
Whereas 20 years ago, asset managers adopting an active management strategy had reasonable prospects of success, in today’s intensely competitive security markets, very few active managers consistently outperform. Consequently, the continued relevance of active management has been questioned with more and more investors settling for the ‘Index’.
An opinion on asset management best practice
With the odds stacked against outperformance, does this mean that the passive route is the best way for investors to achieve their financial objectives? Those at asset management company Marriott disagree. What is required, they believe, is an adaptation to the interpretation of the phrase ‘active management’ to one that places the financial objectives of clients as the benchmark.
At Marriott, when managing portfolios, they start by asking the question: “What does the client require?” They have to look first at the needs of investors, or groups of investors: Do they require a monthly income? If so, at what level? And do they require their income and capital to grow?
Once they have ascertained the clients’ needs, they are in a better position to satisfy them and will construct a portfolio that seeks to address those needs rather than trying to outperform an index.
Step-by-step asset manager advice
The first step in this process is to assess all available financial instruments in terms of client suitability. For example, if you look at the JSE All Share Index, you will see that some 30% is comprised of resources stocks.
For clients such as retired investors, who require a steady income stream, these investments are inappropriate as their dividends and capital values are notoriously volatile. The same could be said about companies that do not pay dividends or companies trading on very low dividend yields. Having filtered the investable universe for suitable financial instruments, you then analyse – on an individual basis – the ability of those instruments to generate a consistent income stream and establish at what rate that income is likely to grow.
With this information you are then able to determine a sensible price to pay for each investment – a price which will ensure an acceptable level of income and capital growth. The end result is a portfolio that will look nothing like an index but rather consist of investments best suited to the needs of a particular investor or group of investors.
By putting aside the desire to outperform and instead aligning the benchmarks of its portfolios with the financial objectives of investors, Marriott is able to increase the likelihood of clients’ expectations being met. This, the company feels, is the essence of active portfolio management.
- Marriott: marriott.co.za