We are witnessing a dramatic flow of money out of active equity mutual funds and a similarly sized flow into index funds. A large portion of these outflows are from so-called closet indexers, funds that claim to be active equity managers but, upon closer inspection, closely track an index while charging active fees. Investors have wised up to this and are heading for the exits, moving into much lower-fee passive funds that provide the same underlying equity return.
The widely accepted style grid of market capitalization and price-to-earnings ratios was largely arbitrary in design, lacking substantial research or academic foundation. An alternative framework based on how managers actually manage their portfolios and organizing around those investment strategies provides a superior alternative for organizing and comparing funds.
Rather surprisingly, the equity strategy framework can provide an estimate of current expected stock market returns. This is accomplished by measuring the recent investor response to each strategy, which, it turns out, captures the deep behavioral currents driving market returns. The resulting information is useful when managing equity market exposure.
Examining investment strategy can be useful when evaluating mutual funds, but what information is contained in fund holdings? Do they reveal stock-picking skill?
High return dispersion and volatility are a stock picker’s nirvana.
Funds that consistently pursue a narrowly defined investment strategy while taking high-conviction positions outperform.
Classifying funds based on their investing strategies instead of via the traditional style grid presents a new way to look at diversification.
A simple question asked over 25 years ago, “How should we group and evaluate active equity fund managers?” has evolved into a powerful foundation for rethinking how we look at markets and investment managers.
As published on Advisor Perspectives July 23, 2018
By Robert Huebscher
How does a proven tactical strategy work when the market signal is driven by behavioral crowds? In this interview, C. Thomas Howard, PhD of AthenaInvest reveals how their global tactical portfolio outperforms with a unique behavioral approach.