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It’s Possible to Identify Top-Performing Managers in Advance

It’s Possible to Identify Top-Performing Managers in Advance

March 18, 2022

Active management can deliver holistic value, help investors achieve their objectives, and weather turbulent markets. And if investors do their homework before selecting a fund, the benefits of active investing can be amplified even further. That was one of the themes of a recent webinar featuring Simon Hallett and Ravi Venkataraman of the Investment Adviser Association’s (IAA) Active Managers Council. The webinar, “Balance the Narrative II: Broadening the Discussion on Active Management,” was hosted by the Mutual Fund Directors Forum. IAA President & CEO Karen Barr served as moderator. The three explained steps investors can take to position themselves for outperformance.

Finding the Right Manager

One of the keys to success is finding the right active manager. Having a steady hand at the wheel can create tremendous alpha and limit risk during downturns, a benefit that only active management can provide. Investors can ask the right questions and do not have to rely on luck to choose the right fund.

“It is possible to identify outperforming investment managers in advance,” said Hallett, Vice Chairman, Harding Loevner. He referenced a Council sponsored paper by University of Notre Dame Mendoza College of Business Professor Martijn Cremers, which aimed to debunk some of the myths surrounding active management and included a section on how to identify top managers in advance. According to the paper, viable predictors of outperformance include a manager’s investment approach, education, work experience, track record, and whether the manager has ‘skin in the game’. The paper also cited a manager’s willingness to hold unpopular stocks and low turnover strategies.

Importance of Active Share

As part of research into a money manager, Hallett urged investors to study active share, or the percentage of stocks in a fund that differs from the benchmark index, which he called a critical element for success. “Active share is a test of whether the active manager is doing what they say they are doing,” he said. “It’s a necessary precondition for outperformance.”

He again pointed to the Cremers paper, which found that high active share and low tracking error (the difference in performance between a portfolio and its corresponding benchmark) are also predictors of outperformance.

Long-Term Horizon

In addition to the above factors, the panelists said it’s important that investors consider their time horizons when selecting an active manager. Patience is key and investors need to stick to their plan despite the daily fluctuations of the market. “The opportunity to add value varies over time,” said Venkataraman.

Hallett echoed those comments pointing out that it’s important that asset owners withstand periods of underperformance that all managers ultimately go through. If an investor sells too quickly or loses patience, they will miss out on the longer-term benefits and the potential for outsized returns.

Barr summed it up, “Active managers can and do add value to investors.”

To hear more thoughts from Hallett, Venkataraman, and Barr on how to select the right active manager and their thoughts on balancing the narrative around active management in general, check out the webinar here.

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