Active AND Passive
By: Roger Nusbaum, AdvisorShares ETF Strategist
I stumbled across the following table:
Percentage of Advisors Using Primarily Active Investments by Asset Class
Over the more than 12 years I have been blogging I have consistently talked about the extent to which markets, portfolio management and investment products evolve and I think this table speaks to the point. While I believe that a 60/40 equity/fixed income is the starting point for portfolio construction, sticking with it with blind devotion is potentially problematic for whenever interest rates rise. Additionally, as the capital markets have more direct participants due to defined contribution plans replacing defined benefit plans, more people are exposed to doing the wrong thing in the face of a large decline (selling after the market falls and watching it go back up while sitting on cash).
These factors along with the ETP industry’s ability to offer new strategies to retail sized accounts that were previously unavailable is that evolution and the table shows assets flowing into these “new” segments as a function of need or at least perceived need. I concede that some funds will simply not be able do what they say they will do (this became apparent during the financial crisis). Mitigating this concern has to involve a proper study of the strategy being implemented, how the fund you choose goes about implementing the strategy and then staying current on research that comes out.
An example of this can be found with managed futures which seemed to always do well but after going up in late 2008, started to decline in 2009 and has been mostly trending lower ever since. One theory that popped up is that managed futures got a lot of its return from a large cash balance (the cash collateralizing the futures exposure) paying 4% or 5% or whatever money markets paid before the zirp era.
The way I specifically interpret the table above is money is moving into segments/strategies that although have been around are new to many advisors and individual investors. Money flowing into these strategies is at least in part recognition that market conditions pose a serious obstacle to overcome (rates got to a point where they could not go lower). It is probably not a good idea for an advisor to learn how to implement a new (to them) strategy with client assets. Additionally, things like tactical strategies and although not on the list I will throw in merger arbitrage, hedge fund replication and any of the other alternative we have discussed in previous posts are potentially full time endeavors unto themselves and the typical advisor won’t have the time and resources to run their own absolute return strategy.
In a related note, Chris Ailman the CIO from CalSTRS was on Bloomberg TV recently talking about the pension shifting assets away from active management to more passive. He said they will now have 30% in active strategies. He said the results don’t justify the fees. The anchor pushed back, asking about using active management to manage volatility which did not seem to resonate with Ailman. CalSTRS of course is far from a passive investor. They have frequently changed their asset allocation targets, most notably adopting the use of hedge funds and then after a run of disappointing returns, rotated out of them. The CalSTRS time horizon is the same it has always been which is infinite so changes in asset allocation are a form of active management.
As I have said before active versus passive is the wrong conversation because most, if not all portfolios have more than an active element to them. Some strategies involve active strategies with passive funds, adjusting asset allocation over time is an active endeavor, when an emergency pops up figuring out how the portfolio will pay for it is an active process, all of which is of course far beyond the conversation of adding alpha with active management and/or managing volatility. Despite his comments Ailman still has 30% in active.
A rational investor, if there is such a thing, will use the best tool for each exposure he wants. Over time the best exposure for a given asset class, strategy or segment will change as evidence by the ubiquity of ETFs.