Every year numerous studies by S&P, Vanguard, Morningstar, and others report that the vast majority of active managers fail to outperform their passive counterparts. What explains active investing’s underperformance vs. passive investing over the last several years? And why do investors continue to hire active managers?
In his popular book What Investors Really Want, Meir Statman explains that investors want to play the investment game and they want to win. They believe their investment advisers can identify skillful active managers. Yet, unfortunately, history does repeat itself: Active managers consistently fail to earn their fees year after year.
What can change this pattern of repeated failure? Investors need to demand better due diligence to separate out the losers. Intermediaries must improve their manager research. The search for skill continues to be conducted with the same lazy tools that have never worked in the past and never will in the future. It’s like the allegory of the drunk and the streetlamp: The drunk loses his keys at night in a park across the street, but he looks for them under a nearby streetlamp because it’s easier to see.
Antiquated Evaluation Tools
The old performance evaluation tools are indexes and peer groups. These are awful barometers of success or failure. Indexes don’t work because many skillful managers don’t live in style boxes, nor do they hug indexes. Peer groups don’t work because they are loaded with biases and are comprised of losers since most fail to outperform their benchmarks. Beating the losers does not make a winner. Peer groups of hedge funds are exceptionally silly because hedge funds are unique, so by definition they can’t be grouped together: “Unique” means without peer. Hedge fund peer groups epitomize classification bias because the members don’t belong together. (For further details, see “The Compelling Case for Changing Hedge Fund Due Diligence.”)
Investment management consulting is a fungible credence good: a service that is difficult if not impossible to properly assess before or even after consumption. Credence good markets emerge when sellers are much more knowledgeable than buyers. This fact has propelled so-called “robo-advisers” into the limelight, because if you can’t tell the difference, you might as well buy the cheapest.
Clients (buyers) need to wise up. There’s a good reason why active managers selected by consultants fail to deliver value add: Consultants aren’t trying hard enough because they don’t have to. This laxity applies to advice-only consultants as well as outsourced chief investment officers (OCIOs). It would be better to not pretend at all. That’s why intellectually honest robo-advisers have given up on the search for skillful active investment managers.
see more at: https://blogs.cfainstitute.org/investor/2015/10/07/better-investment-consulting-is-long-overdue/
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