Competitive Threats Emerging For Active Mandates
Traditional active management for retail investing is also seeing a new competitive threat. It’s not coming from rules-driven exchange-traded funds (ETFs) but from the opposite side; namely, private equity managers.
Private equity managers such as Blackstone aim to increase their management fee income by going down-market to the $1-5 million household level, down from the $5-25 million-level alternative asset managers typically market to.
Whether these interval funds prove to be successful, particularly when they’re being launched at what is arguably the peak of the business and credit cycles, the willingness for private equity firms to enter the retail marketplace is yet another indication that the value proposition of traditional active managers will come under further scrutiny.
In many ways, private equity represents the pinnacle of conviction-driven, fundamental investing, where the “investors” presumably know so much about the companies they’re investing in they can effectively operate them as well as current company management.
Hedge funds are also having a better year, although the “quant” category is stumbling due to bond market and currency volatility. After having failed to meet expectations for the last several years, hedge fund investing may start to see a comeback alongside traditional active management.
Alternative Framework For Evaluation
In constructing an asset allocation, the investor can decide whether to invest in pure passive strategies that select and weight securities based on the market’s assignment of “value” (market capitalization for equities, debt issuance for fixed income) or whether to deviate from the market consensus and opt for alternative weighting schemes.
The latter can be implemented using rules-based smart-beta (factor) indices through ETFs or through the judgments of a professionally managed portfolio as embodied by traditional active management.
With the advent of ETFs, smart-beta factor investing has brought more transparency to investment programs that deviate from traditional market-cap-weighted indices, such as decomposing sources of active returns (is it factor-driven or skill-driven?) and costs (what are the incremental costs between a smart-beta portfolio versus a traditionally managed portfolio?). Investors can better determine where the value is being delivered and at what cost.
Having access to tools to better evaluate sources of value-add and the associated investment costs calls for an alternative framework when judging performance of the overall investment program.
Whether investing in traditional actively managed strategies or smart-beta indices, investors need to own more of the resulting asset allocation, primarily the residual performance stemming from the choice to invest away from market capitalization-weighted indices (e.g., the S&P 500 Index and the Bloomberg/Barclays Aggregate Bond Index).