Active edge – an introduction
27 July 2020 | Portfolio construction
By Andrew Surrey, senior national development manager, and Nick Davis, senior national development manager.
As one of the largest active investment managers in the world, with more than £1 trillion in assets under active management globally1, our active capabilities are probably our best kept secret. But it shouldn’t be a surprise – our heritage is active; the predecessor of our Global Balanced Fund was launched in 1929 and today remains one of the oldest surviving mutual funds in America2. Our experience has taught us what it takes to succeed in active and we put everything into delivering high-quality active funds that bring value to investors.
Globally, more than 90% of our 97 active funds outperformed their peer group average over the past ten years3. That’s a product of our CEO-led active investment process, which is really built around a longer-term perspective with exceptional talent driving investment decisions.
Of course, periods of underperformance are usually par for the course with active investing, even for the best active investors4. That’s why choosing the right manager is so important, because failure to achieve net outperformance in the long term is a very real and significant risk with active strategies.
Often we find talented managers internally, while sometimes to achieve a balance of complementary styles we appoint external managers. Whether internal or external, our selection process is focused on identifying managers that possess an ‘active edge’, which in turn forms part of our edge in active management.
Vanguard’s active edge
Over the years, we’ve honed the three core principles that underpin our approach to active: we allow investors to keep more of their return through low costs, we aim to hire some of the best managers in the world and we are patient, allowing alpha to materialise over a period of time. This is what we believe gives us an edge in a highly competitive field.
Keeping costs low is part of our DNA at Vanguard and it’s no less important in our active business than in our index funds. High costs eat into alpha, making the difficult task of delivering net outperformance even harder for managers that charge a high fee for their services.
Tapping into quality talent is crucial. We spend a great deal of effort in identifying highly skilled managers. We see it as our responsibility to work with the top active talent around the world to deliver value to our investors. That responsibility has turned into one of our greatest strengths. As one of the world’s largest buyers of active management and through decades of experience, we have developed and honed an expertise in identifying talent.
An important part of our approach is patience. Our commitment to enduring outperformance means we think in decades, not years or quarters. We look to form long-term, high-level relationships with our external partners – our relationship with Wellington Management traces back to 1958 – and we understand that periods of underperformance are normal for many top managers. Long-term net outperformance can only be achieved with patience.
How do we find managers with an edge?
As touched on above, working with top-quality talent is key to successful active strategies. Data is an important tool in identifying top performers but it will only get you so far. After all, yesterday’s winners aren’t necessarily the winners of tomorrow – Vanguard research found that only 13% of active outperformers during a bear market continued to outperform in the subsequent bull market, while only 19% managed to outperform in a bull and subsequent bear market5.
A competitive advantage isn’t all in the numbers. In our experience, it stems from a combination of qualitative factors that are unique to each manager or fund. There is no formula or algorithm that can be extrapolated to generate successful active strategies, but there are some fundamental characteristics shared by successful managers.
Over the years we have narrowed down these traits and characteristics into four pillars of assessment that we use to guide our search for active managers:
- Firm: we look for organisational structures that are aligned with shareholder interests as well as a firms’ ability to attract, retain and motivate talented investors.
- People: we seek outstanding talent and passion, intellectual diversity, experience and cohesion. At the same time, we avoid ‘star manager’ cultures and place great importance on diligent succession planning.
- Philosophy: we seek investment approaches that are distinctive and enduring.
- Process: we look for proven, disciplined processes centered on proprietary research.
Where a manager makes the grade in each of these assessments, we expect two outcomes:
- Portfolio: a clear reflection of the philosophy and process in the portfolio and a risk profile aligned with the investment strategy.
- Performance: a track record consistent with the investment approach with compelling, risk-adjusted returns against benchmarks and peers.
We will explore these factors in greater detail in forthcoming blogs – in the next instalment we cover some of the teams managing mandates on behalf of Vanguard investors. We will take a look under the bonnet to explain what gives them an active edge and also why we blend some managers together – and others not.
1Vanguard, as at 31 May 2020.
2The Wellington Fund became the Vanguard Wellington Fund in 1980
3Vanguard, Morningstar as at 31 March 2020.
4 Wimmer, Chhabra, and Wallick, 2013
5Vanguard calculations, using data from Morningstar, Inc. Equity funds’ returns in excess of their prospectus benchmark between the crisis period ranging from November 2007 to February 2009 (global financial crisis) and the subsequent bull market ranging from March 2009 to January 2020.
This document is directed at professional investors and should not be distributed to, or relied upon by retail investors. This document is designed for use by, and is directed only at, persons resident in the UK.
Investment risk information:
The value of investments, and the income from them, may fall or rise and investors may get back less than they invested. Past performance is not a reliable indicator of future results.
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