Active funds earn keep, barely, in bear markets: James Saft

November 4, 2015

Nov 4 (Reuters) – Active fund managers’ skill in timing bear
markets may be enough to balance their costs and other

That’s the upshot of a new paper, but before you get too
excited, the implication may simply be for investors to be more
or less indifferent to the active vs. passive debate.

Unless, of course, you think you can predict bear markets,
in which case you are likely already an active investor, as well
as being a seer.

Numerous studies have indicated that active managers produce
worse returns than passive benchmarks. A new study from J.
Spencer Martin of the University of Melbourne and George J. Wang
of Manchester University computes an option-based valuation of
active managers’ timing skill during bear markets added to
security selection value. This adds to evidence from earlier
studies that active managers outperform, or produce alpha,
during market downturns.

“Our findings imply that professional managers, as a group,
are covering their costs rather than destroying value,” the
authors write in the study, updated in October. (here)

“We find the option-adjusted alpha is statistically
indistinguishable from zero. This finding suggests that the
benefit of the service provided by fund managers may actually
fall in line with its cost.”

That description of active fund management’s offering:
“alpha is statistically indistinguishable from zero” will not
make it into large type in many funds’ marketing materials, but
the implications, if true, are substantial.

What’s more, the data indicates that the zero alpha offering
holds good not just for active fund management in aggregate but
at the portfolio level.

Looking at fund performance from 1986 through 2010, the
study finds that active managers do better than previously
thought, in part because the value of market timing skill is
higher during bear markets, when volatility, as measured by the
VIX index, is higher.

By better reflecting the option value of market timing
around bear markets, the study purports to show that active
managers’ virtues “can be large enough to compensate for other


Clearly the debate around active fund management performance
will continue, with many on the active side arguing that manager
selection can provide alpha, a view not backed up by this study,
at least.

The conclusion, that active management can more or less pay
its own way, isn’t earth-shattering. It does accord with the
economic theory that mutual fund managers, like actors in any
other economic sphere, will do work, in this case collecting and
analyzing market information, only up to the point where the
marginal benefit meets the marginal cost.

That view may well be correct, though there are plenty of
examples of economically irrational activity.

Some of the implications of the study, if confirmed by
further research, could be profound.

“As such, unconditional negative alphas relative to passive
benchmarks do not necessarily imply that fund investors have
suffered significant welfare losses, or that investors do not
want to invest in those funds, or that index funds should be
overwhelmingly preferred,” the authors write.

That first idea, that fund investors suffer a loss through
active management, is both common and underlies plans to address
failings in the pension savings system in the U.S.

A rule now proposed by the U.S. Department of Labor will if
enacted force financial advisors selling retirement products and
advice to act as fiduciaries, meaning that they would be obliged
to put clients’ interests above their own.

Fund analysts at Morningstar last week said that that
fiduciary standard may send $1 trillion of additional assets to
passive investment products.

That’s partly because smaller accounts will be uneconomic
for full-service advisors who tend to place clients in active
products with larger fees. That certainly was the experience in
the UK, where the passing of similar rules led to a fall in the
number of advisors and a rise in passive investment, as well as
of low-cost fund-allocation platforms.

Remove the idea that passive is better and you remove some
of the justification for those changes.

This all begs the question of why an advisor might argue for
active fund management if it was only going to produce “alpha
statistically indistinguishable from zero”. At least it keeps
fund managers, who might otherwise get on their spouses’ nerves,

Being good during bear markets may not turn out to be
(At the time of publication James Saft did not own any
direct investments in securities mentioned in this article. He
may be an owner indirectly as an investor in a fund. You can
email him at and find more columns at

(Editing by James Dalgleish)

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