Active Managers Offer Keys to Success
Low fees, deep resources, long time horizons, and determination have helped these winning managers.
This analyst blog is part of our coverage of the 2017 Morningstar Investment Conference.
Stock fund investors have voted with their feet, perhaps with good reason. Less than a third of active equity funds have outperformed their benchmarks and passive alternatives after fees in the past 10 years, and more than $1 trillion in assets has flowed out of active funds in that period while passive funds have raked in new money. It's enough to make stock-pickers throw up their hands and cry over their portfolios.
Hope springs eternal, however. If 73% of active stock-pickers failed over the past decade, that still means more than a fourth of them succeeded in besting their benchmarks. Three managers from that winning quartile said Thursday at the Morningstar Investment Conference that the keys to success are low fees, deep resources, long time horizons, and the willingness to doggedly ferret out information and insights that the rest of the market doesn't have, doesn't understand, or is unwilling to wait for.
Matt Fruhan, manager of Fidelity Large Cap Stock (FLCSX) and other funds, cited his firm's (it should be said, somewhat self-serving) analysis that found the active versus passive debate in the large cap market looks a lot different when you screen funds and managers on two basic factors--fees and scale. Yes, most active large cap stock managers have lagged their indexes since 1992, Fidelity found. But when you look at funds with fees in the bottom fourth of their peer groups from firms capable of providing their managers with above average breadth and depth of analytical resources (defined rather bluntly as the top five fund complexes in terms of assets under management), the results switch.
Most large cap managers clearing those screens have outperformed benchmarks, Fruhan said. He added that beyond low fees and deep analyst ranks, having a long time horizon helps active management because, despite the rise of passive investing, the stock market is still short-term focused. It's sometimes difficult, for example, to find earnings estimates for stocks longer than one or two years out, said Fruhan, who claims to invest with a three- to five-year time holding period.
The job of beating the benchmark has gotten, or looked, tougher in recent years, Fruhan admits, but that's because low interest rates have encouraged speculation and yield chasing in equities, which has driven up market valuations, including among dividend-paying stocks that are a staple of large-cap managers. Anyone adhering to a valuation discipline has missed out on at least some of the last eight years' gains.
Short-term-ism becomes increasingly harder to resist the longer a bull market chugs forward, said Clare Hart, manager of JPMorgan Equity Income (OIEIX). Her dividend-focused fund has downplayed utilities, REITs and consumer staples in recent years as investors seeking income and bond alternatives have driven up valuations. There's tremendous pressure on portfolio managers to explain to clients why they’ve left money on the table in those areas. Some capitulate.
"Portfolio managers are people, too," she said.
But it's better to have a philosophy and process and stick with it because the market always returns to fundamentals even if there is a delay sometimes.
More dispersion and less correlation among stocks would help active managers' causes, said T. Rowe Price Value (TRVLX) manager Mark Finn. That condition does not prevail today, Finn, and other managers at the conference, such as Charles Pohl of Dodge & Cox, said.
Finn, however, concurred with Fruhan that fund families with more resources, long-tenured managers, long-term focused strategies, and reasonable fee structures aid and abet successful active management.
"We've found that is the recipe for consistent, stable outperformance over our benchmarks," Finn said.
Each of the managers conceded that their stomping grounds--large-cap stocks--are usually closely followed and well picked-over. But they contended it's possible to gain an analytical advantage even in an efficient market.
Hart, though she has analysts on her team and can rely on a large and experienced central stable of industry researchers, still likes to do her own work on stocks and attend company meetings to see and hear how company executives react to and answer questions.
"You just pick up stuff," she said.
Her comments jibed with what author Michael Lewis, author of The Undoing Project and other books, said. Data-driven sports executives, Lewis said, have learned not to ditch qualitative interviews with prospects because even though the sessions open the door to biases and errors, they still do occasionally provide crucial bits of information.
The ability to do deep, long-term research across the market also can give active managers an edge, said Finn. He said he's owned Microsoft (MSFT) for almost his entire roughly seven-year tenure at T. Rowe Price Value. He bought it when it was cheap and considered hopelessly tethered to writing operating systems for increasingly outdated personal computers. The work of his firm's growth managers and analysts on Amazon.com (AMZN) and its Amazon Web Services business encouraged Finn to pay closer attention to Microsoft's competing Azure cloud computing unit. That business line's potential helped bolster his conviction to stick with and add to a successful position in Microsoft over the years.
"A passive approach is a conscious decision not to outperform," Finn said.
Dan Culloton does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.