Last year posed huge challenges for active investment as markets were driven by politics rather than economics. Stephanie Baxter looks at research showing a large fall in managers beating the benchmark
Active investment managers are having a difficult time as markets are being driven much more by politics than the economy.
While uncertain times can present opportunities, surprise events including the UK's vote to leave the EU on June 23 and Donald Trump's US election victory on November 8 were like none seen before.
The struggle for active managers is underlined by Lyxor Asset Management's latest research, which reveals very few outperformed their benchmarks last year, with results far below the previous year.
Analysing the performance of 3,871 active funds (including equity and fixed income) domiciled in Europe totalling €1.3trn (£1.1trn) compared with their benchmarks, it found just 28% outperformed in 2016 - far below the 47% that did so in 2015.
The study attributes this marked change to market conditions being devoid of significant trends.
Head of exchange traded fund (ETF) research Marlene Hassine, whose team carried out the analysis, says while 2015 was a "very good year" for active managers, 2016 presented challenges in generating performance and taking advantage of trends.
"The start of 2016 was very difficult for active managers with questions over China's growth, warning signs of a US recession, and the oil price fall. Managers then struggled to maintain strong confidence due to the move away from economics towards politics."
When broken down between asset classes, 27% of equity active funds outperformed on average, which is just half of the figure for 2015. The results were particularly bad for European equity, where just 19% of funds outperformed compared to 72% in 2015. Across UK equity, a fifth of funds beat their benchmark, another big decline from the 56% that outperformed the previous year.
Meanwhile, 31% of fixed income equity funds beat their benchmark, slightly down on the previous year's results.
Despite the large difference between the 2015 and 2016 results, the latter are actually more in line with long-term data. Just 19% of all European-domiciled managers have outperformed over 10 years (including the financial crisis), and very few managers beat their benchmark over a whole market cycle. The picture looks slightly better over a five-year period where 24% of funds outperformed, boosted by strong results in 2015.
UK equity active funds also fared much better over a five years where half beat their traditional benchmark, falling to 34% over 10 years, and 29% over three years.
Lyxor identified clear trends explaining why funds underperformed or outperformed in 2016. According to its analysis, 95% of information of fund performance falls into five factors: market, small, value, momentum, low beta, quality.
The best performing managers of 2016 backed the value (low valuation) risk factor theme at the expense of low-beta, quality and momentum factors.
Meanwhile, the worst performing funds tended to have overweight exposure to the momentum, low beta and quality factors, and were underweight value.
The results are also consistent with the argument that more opportunities are found in less efficient markets, as the research found small cap, emerging markets and euro corporate bond markets as the best example of where managers can generate alpha.
The study also compared the performance of active funds in Europe with smart beta indices created using criteria that are not based on market capitalisation. Active funds performed very poorly here, with only 13% beating the smart beta indices such as the FTSE Minimum Variance Indices. Overall, active managers underperformed the smart beta benchmark by 3.1% while adding 1.3% of volatility in 2016. The picture is much bleaker over a longer period of 10 years, where as little as 5% active funds outperformed smart beta.
There are still opportunities to be found in active, however, given that the best performing manager outperformed by more than 8% in 2016, and more than 9% in Q1 2017. But it highlights the importance of selecting a good manager, which is difficult given the old adage that most active managers do not outperform consistently. Lyxor's research shows on average 36% outperformed in their first year but only 15% were still beating the benchmark in the second year, falling to 6% in year three.
So far, this year has been slightly better for active managers with data for Q1 2017 showing 34% have beaten their benchmarks. Looking forward, Hassine says she believes as the economic environment changes with the move towards less quantitative easing, this could be more favourable for alpha generation.
However, given the continued political uncertainties particularly in Europe, this year is set to be another challenging one for active management. The spotlight on active investment is getting more intense when it is already under heavy pressure to demonstrate its value.
Ross Trustees has secured investment backing from private equity investor LDC, as it prepares to capitalise on growing demand for professional trustee services.
Lee Sanders says the fast and adaptive market response to the crisis of 2020 has shown how much the financial system has improved upon the credit market liquidity issues that were at the heart of the 2008 global financial crisis (GFC).
The stabilisation of US economic growth amid unprecedented fiscal and monetary stimulus has raised questions about the likelihood of inflation returning. Global Head of Fixed Income, Jim Cielinski, and Global Bonds Portfolio Manager, Andy Mulliner, explain...
GLIL Infrastructure has agreed to acquire a 30% equity stake Agility Trains East (ATE) for a rolling stock fleet of 65 new UK intercity trains from Tokyo-headquartered Hitachi Rail.