Active equity managers responsible for portfolio diversification, have traditionally looked to products like hedge funds to create maximum exposure and leverage. The downside of hedge funds, is that directional volatility is exaggerated. While generating higher earnings than say, bond or mutual fund investments, these once considered progressive equity products are being seconded in response to outperformance goals. Portfolio scrutiny by equity managers interested in exceeding benchmark performance rankings, now look to new products to advance profits.
Mercer’s global investment manager database reporting on the outperformance of global active equity managers shows that in spite of the fact that they have generated substantial liquidity for clients in aggregate over the past 30 years, the pace of outperformance has been inverse. At the end of Q4FY13 median performance for global active equity managers was actually trailing industry performance benchmarks on both the three and five year indices.
If equity managers have good faith in the potential of outperformance at this time, it is not surprisingly turning into a mixed environment, partly focused on fundraising, and partly on investor protections in the interest of sustained profits. The fact that outperformance is a rule of thumb and not a benchmark, points to the efficacy of behavioral theorist in the field of finance. How else to justify the emphasis on outperformance as a criteria to confidence between an active asset manager and investor clients?
Indeed, equity managers have been faced with a range of challenges since the global financial crisis of 2008. The institution of new regulations has had a domino effect, as institutions respond with structural changes. How effective an equity manager is in creating stable liquidity for investor clients, has much to do with cyclical market changes as well. The convergence of these external forces has, albeit, impacted rates of return paid to managers.
Equity managers employed with large banking institutions may be experiencing different conditions than those working as consultants or employed in a pure-play investment firm. Franchise brokerages encouraging contributory cash flows to a firm or institution are said to be more homogeneous in outperformance. The stakes are far higher in such case. Moreover, technical changes in automation and more complex algorithms used in financial analysis have influenced equity market analysis across the sector, and investment manager behavior in response. This is particularly true of large-caps funds, reducing outperformance.
In the past five years, benchmark performance by most equity managers has been closer to reference indices, rather than target results accorded fee differential projections. The application of information ratios to determine whether asset contracts will increase exposure or the return per unit of risk reflects a general shift in the equity market away from passive investment.
Managers employed to track portfolio activity and risk are also keenly aware of the active share of a portfolio. The proportional distance of a portfolio’s asset valuation from its benchmark performance, is the standard measure used to predict end-of-year results to an active asset account. There are two investor behavior dynamics used by equity managers that add value to an account: 1) concentrated selection of assets based on high levels of exposure; 2) diversified asset selection promoting stable outperformance, and less risk.
Active asset managers also focus on other investment activities that may increase the information ratio. For instance, an emphasis on small-caps will outperformed large-caps over time. Stronger research focus also assists in building value into a portfolio by reducing error. Market dimensions found in international investment products, timing, macroeconomic effects, trading cost, and company financial research are critical to outperformance.