Since the events of the global financial crisis in 2008/09 most markets have gone up, driven mainly by quantitative easing. This has made it very difficult for any active manager to outperform.
However, following large capital flows from active into passive investing and changing regulations, could active managers outperform in the future?
Investors have moved huge amounts of capital from active to passive funds. This change started in 2006, even before the crisis. According to Morningstar, the size of the passive fund market in the USA now equals the assets in active management. As passive funds buy all holdings in an index indiscriminately, with no sense of value, could active managers now have a better chance of exploiting this? I feel active managers could capitalise on less money chasing market mispricing and outperform over the long-term, although managers would need to hold concentrated portfolios to capitalise on this, which increases the risk. For risk averse investors passive funds will still be preferable as the appeal is in their diversification, where a single holding declining in value would not have a material effect.
Since the introduction of MiFID II in January 2018, asset managers have been required to make direct payments for investment research rather than using clients’ trading commissions to cover the cost. Due to the large fees involved, many asset managers do not want to pay for research which was previously free. As a result, many brokerage firms have cut their research personnel. Given that there are fewer analysts covering stocks, could this lead to more mispricing and extra opportunities for active managers (who have their own research capabilities) to add value?
Over the short-term it may not make any noticeable difference due to the depth of coverage particularly for large caps. However, over the long-term we may see fewer research analysts in general which could lead to better opportunities for active managers. Small cap active managers generally have more success in adding value verses their large cap peers, partly due to a lack of research coverage. With MiFID reducing the number of research analysts even more, small caps may become an even greater area of the market where active management can outperform.
With the ever increasing flow of capital from active to passive funds and with less research analysts identifying mispriced stocks, perhaps there is a future for active managers to outperform.