At a time when active strategies have produced lacklustre returns relative to cheaper passive options and the lower for longer environment has become the new norm, investors must take a more contrarian approach to manager selection said WTW.
“Most attempts to outperform equity markets will fail,” the global adviser and insurance brokerage bluntly declared in a note to investors.
At the same time, “investors are in great need of added returns from manager skill due to an environment of expected low return”.
One of the most useful measures of identifying funds that are going against the grain is active share, the firm argued.
In the long-term, academic studies have shown there is a clear correlation between high active share and outperformance. But too often, equity managers are stuffing their portfolios with low-conviction “filler” stocks to make the portfolio appear more like the benchmark, “dampening relative risk while decreasing active share”.
“This vicious cycle leads to sub-optimal equity portfolios that are doomed to (almost always) fail,” it said.
Diverse multi-managers
To diffuse the higher short-term risk associated with concentrated, contrarian funds, WTW advised spreading it around approximately eight to nine other concentrated products with uncorrelated specialisms.
According to WTW, a diverse multi-manager approach “maximises the chances of long-term success and significantly reduces the risk of material underperformance over a reasonable investment horizon”.
“When hiring one manager, dependency on that manager for long-term success is a one-sided bet. However, combining lots of uncorrelated managers provides far more diversity of thought, research process and decision making, thus increasing the odds of success over the long-term.”
“Contrarian portfolio management can add to long-term returns,” it continued. “Investors should be willing to add capital to underperforming managers and take it away from strong outperformers.”
Costs are also a key consideration when attempting to better returns over the long-haul, which is why investors should seek out managers that typically have low-turnover and tax efficient vehicles.
