Active vs. Passive
20 May, 2016
2015 saw some improvement for actively managed funds compared to their
respective passive benchmarks. Of course that was an easy bet after 2014 went
down as the worst year for active managers in the U.S. According to the S&P
SPIVA reports (Standard & Poor’s Index Versus Active), 34% of large cap
managers outperformed the S&P 500 in 2015, much better than the 14% the
previous year. However, this 34% may be understated. There was a significant
divergence in style last year, with the S&P 500 Growth index rising 5.5% while the
S&P 500 Value index fell 3.1%. There are about 33% more value focused funds
compared to growth funds in the U.S., so naturally if value underperforms growth,
the number of managers beating the broad index will be lower. The S&P report
doesn’t include this point for some reason.
A better measure, which is included in the report, is asset-weighted fund
performance. Last year the asset weighted return for All Large-Cap Funds was
0.9% compared to 1.4% for the S&P 500, a rather minor underperformance.
Interestingly, the equal-weighted performance for this fund group was -0.3%. That
means funds with more assets tended to perform better. Or perhaps managers
that are better performers receive more assets to manage. Bit of a chicken and
egg. Still, a 0.5% underperformance isn’t that much in our view. The chart below
shows the asset-weighted performance over a number of trailing time periods for
both Canada and the U.S. And yes, Canadian managers continue to outperform.
We will explain why shortly.
Still the numbers do stack up rather ominously for active managers in this debate,
which is sure to continue. Notably in the U.S. market managers typically trail the
S&P.
U.S. Large Cap vs. S&P 500
Canadian Managers vs. TSX
8%
14%
6%
12%
4%
10%
2%
-2%
6%
-4%
4%
-6%
2%
-8%
0%
-10%
1-year
3-year
All Large-Cap Funds
5-year
10-year
S&P 500
Richardson GMP Asset Management
Craig Basinger, CFA
Chief Investment Officer
416.607.5221
[email protected]
Chris Kerlow, CFA
Derek Benedet, CMT
Analyst
416.943.6156
[email protected]
0%
8%
Market Ethos - Ethos is defined as the
character or disposition of a group. In this
case it’s the disposition of the market
itself.
Analyst
416.943.6156
[email protected]
Are Canadian Portfolio Managers Really Better?
16%
Connected Wealth Market Ethos posts
are market thought pieces from the
Richardson GMP Asset Management
team. As part of our philosophy for
managing money, we believe in providing
quality objective advice and services with
greater transparency. These reports are
designed to provide a deeper look into
our current thinking.
1-year
Canadian Equity
3-year
5-year
S&P/TSX Comp
Source: Richardson GMP Asset Management, Bloomberg
2
MARKET ETHOS
When to be Active, When to be Passive
We believe there are two critical factors that determine which investment style has the upper hand. But before we discuss these, our
underlying contention is that neither is necessarily superior and to be honest, you can’t prove one over the other. After a couple
years that very few managed to consistently outperform the index, one may argue the verdict is in. However, the pendulum swings
both ways, and even though the recent history has seen passive as a better strategy, this pendulum can, and will, swing the other
way. Just like a fund that returns 50% will not likely repeat such a feat, and studies show there is a larger probability this
outperformance will be followed by underperformance. The most widely stated disclaimer in this industry is ‘past returns are not
indicative of future performance’, for good reason as it is true. We believe the relative performance of active vs. passive
management is a more cyclical relationship and there are times to be more active and there are times to be more passive. The key
two drivers of this are index construction and the market environment.
Index Construction – This is why Canadian managers outperform their index more often than U.S. managers
As the active vs. passive debate is all relative to a benchmark, how that benchmark (passive option) is constructed is critical. Some
indices are better balanced and some are not. We believe those
Comparing sector diversification between the TSX and
that are not well balanced or constructed are easier for active
S&P 500
managers to outperform or add value.
40%
25%
20%
15%
10%
5%
Canada
Utilities
Telco
Technology
Financials
Health Care
Cons Staples
Cons Disc
Industrials
Materials
Energy
0%
U.S.
Disparity & Leadership models starting to favour active
70%
% outside +/- 10% of Index
Average
60%
50%
40%
30%
20%
10%
Jan-16
Jan-15
Jan-14
Jan-13
Jan-12
Jan-11
Jan-10
Jan-09
Jan-08
Jan-07
Jan-06
Jan-05
Jan-04
Jan-03
Jan-02
Jan-01
Jan-00
Jan-99
Jan-98
Jan-97
Jan-96
0%
Jan-95
Index construction applies to other asset classes as well. The
Canadian preferred share market is not efficient and often lacks
liquidity. Again this gives another advantage to the active manager
over the passive ETF.
30%
Jan-94
Some indices are better balanced or constructed than others.
Those that are poorly diversified should be easier to outperform
using active management. Or at the very least, should be easier to
better diversify the embedded risks built into the index. From our
experience the TSX is easier to outperform than the S&P 500, which
is arguably better diversified. The top chart contrasts sector weights
between the U.S. (S&P 500) and Canada (TSX). As you can see
there are a few sectors extremely lacking in Canada and a couple
that have extra big weights. The U.S. at the very least appears more
balanced.
35%
Jan-93
The vast majority of indices are market capitalization weighted,
meaning bigger cap companies carry bigger weights. But they are
also constructed based on the companies trading on an
exchange(s) or in a specific country. The index simply becomes the
residual of the companies trading in a country. This creates
distortions when compared to the economy. Consumer stocks
represent 10% of the TSX but a far greater portion of the economy.
It can be distorted by a few mega companies. Nortel did this to the
TSX years ago. What if Apple moved to Canada to enjoy our lower
corporate tax rates or more interesting weather? Without
constraints it would be over 1/4 of our index, yet nothing has really
changed. Valeant rose to over 5% of the TSX, yet it was largely a
U.S. company. Today it is safely below 1%, but the lesson remains.
Market Environment – This is a big driver and we believe it has a
more dramatic impact on the relative performance or success of
Source: Richardson GMP Asset Management, Bloomberg
active vs. passive. And it tends to be cyclical. We believe there are
two kinds of markets, macro driven and micro driven. Macro driven markets are those where big data points, such as central bank
policy, economic data or other broad reaching forces are the bigger drive of performance. Conversely, micro driven markets tend to
have individual company or fundamental data as the bigger driver of performance.
While this is still a macro driven market, thanks to monetary policy, zero interest rates for so long, and other market evolutionary
factors, there are rising signs of change. The 2nd chart is index disparity. This is relatively straight forward, when disparity is low the
index and all its constituents are moving in a big herd. Again this is often caused by macro forces impacting the whole market.
However, when the macro abates it is micro that matters including company fundamentals. When this happens the disparity of
MARKET ETHOS
3
returns across index members increases. If you are an active manager, your chances are better for adding value when there is
greater dispersion. As you can see the chart the past five years has seen very low dispersion, which lines up with the SPIVA reports.
However dispersion has been rising, which may give active a better change in 2016.
Conclusions
►
The past few years have been a very tough environment for active management relative to passive. This time last year we
were firmly in the camp that passive was likely to be the winning strategy for 2015 but this is now changing. A few models
have started to favour active and we will likely be tilting our profiles accordingly.
►
At present, our investor profiles have passive allocations of 56% for Conservative, 42% for Balanced and 43% for Growth.
We will likely reduce these somewhat in the coming weeks. However we remain convinced having a combination of both
active and passive is the best of both worlds for a portfolio.
The research above is prepared by Richardson GMP Limited and is current as at the date on page 1. Richardson GMP Limited is a member of the
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