Here is an interesting recent article from Morningstar: Where Do Active Fund Managers Hold the Upper Hand?
The main point of the article is to identify financial markets or asset classes that seem to be more vulnerable to successful active investment management. The argument goes like this…
- Sure, active investment management is hard.
- But it’s easier in less competitive markets where there is less information available about investment opportunities.
And based on the data in the article this hypothesis makes sense.
The author mentions how active fund managers are more likely to outperform in markets such as real estate, high yield bonds, and emerging market stocks. And certainly on a 1 year time frame, that appears to be the case.
But let’s not forget that long-term results are what matters. And based on the Morningstar data, over longer periods of time, the chances of an active manager out-performing in these “less competitive” asset classes are closer to a coin flip.
A better way to look at it
Here is the way I think about the Morningstar article:
- Sure, active investment management is hard.
- But it’s easier in less competitive markets where there is less information available about investment opportunities.
- Better investment opportunities will ALWAYS attract more competition. And the probability of out performing in the future will go down.
Any market that offers sufficient opportunities for profits will always attract more competition. On it’s face, the Morningstar data appears to support the idea of better opportunities for active managers in less competitive markets. But what will happen in the future? My guess is that more active managers will enter those markets in the hope of generating profits. And the increased competition will make it harder for the average active manager to outperform.
It’s important to note that passive investors neither outperform nor underperform, they merely match the broader market. The active manager’s main goal is to do better than the other active investors. That’s a really important point so I’ll repeat it. The active manager is competing against other active investors, not against passive investors. Long-term passive investors have essentially removed themselves from the competitive playing field and made the choice to let the market decide their results.
And don’t forget that active managers don’t work for free. The costs of active management can have a tremendous effect on the performance of the active manager (as illustrated by the Morningstar data).
Don’t just take my word for it. William Sharpe wrote a seminal article in 1991 called The Arithmetic of Active Management. As a whole, it’s impossible for active managers to outperform passive investing.
The author at Morningstar is right to point out the differences in active management across a variety of asset classes. But don’t assume that the good results will continue for active managers. The future is what matters, and as they say, “the past is history, the future is a mystery.”
