Value investment veteran Bill Miller has weighed into the increased challenge passive instruments are posing to active managers by creating a six point check list all investors should look for.
In a commentary entitled ‘Why do we invest in active managers again?’, Miller said the passive versus active debate is not going away, there are certain things investors should focus on when properly assessing active managers.
1. Compelling long-term record: Miller said: ‘As everyone knows: “past performance does not guarantee future results”. However, managers who have outperformed their benchmarks by wide margins over very long periods of time are much more likely than managers with bad or mediocre performance to be doing something right. By “long term,” we mean many years, as longer timeframes are more statistically significant.’
2. Repeatable competitive advantage: ‘A good manager should be able to explain their competitive edge,’ said Miller. ‘Which is why that edge may enable them to outperform the market in the future.’
3. High active share: Miller said active portfolios that do not differ significantly from their benchmark are likely to perform similarly to the benchmark but charge higher fees, which is a recipe for underperformance.
‘While high active share increases the likelihood of outperformance, it will come with high performance deviation from the benchmark on both the upside and downside, which investors must be prepared to tolerate.’
4. Reasonable fees: ‘Costs are the biggest headwind for performance and the primary reason that active management, in the aggregate, fails to outperform passive benchmarks. Higher-fee strategies, such as hedge funds, are much less likely to provide compelling returns than are similar strategies with lower fees.’
5. Low turnover: Turnover is a hidden cost that investors need to consider, Miller said. ‘Strategies with low turnover and longer timeframes are more likely to outperform high-turnover strategies with similar investment approaches, as higher turnover means higher costs.’
6. Wide opportunity set: ‘Constraints are an impediment to solving problems of optimization, and portfolio management is an optimisation problem,’ Miller said.
He added that the smaller an investable universe, the lower the probability that an asset exists within that universe that will outperform the benchmark.