How to pick the right active investment managers
By Dan Newhall, Head of Oversight and Manager Search, Vanguard.
Index funds offer a good starting point for all investors but active strategies can play an effective portfolio role too if you’re comfortable with taking on extra risk in pursuit of market-beating returns. Success with active funds, however, is not guaranteed and investors accept the very real possibility of long-term net underperformance against a broad market index when deciding to go active.
That’s why choosing the right managers to oversee your active investments is so crucial. As buyers of active management for the past 40 years, picking managers is something Vanguard has learned to do very well.
Whether from within our ranks or from other leading fund managers, we bring together some of the brightest minds from around the active-investing world. In some cases, particularly equity strategies, we combine different managers on a single mandate to construct well-diversified portfolios that target lower ‘active risk’ (measured as tracking error)1.
It’s an approach we have refined over many decades. And while size isn’t everything, our track record suggests we’re doing something right – globally, almost 90% of our active funds globally have outperformed their peer-group average over the past ten years2.
We’re confident our approach to active is right for most investors seeking alpha and we want to share some of that wisdom as part of our ongoing commitment to support advisers in delivering value to investors.
Data will only get you so far
Identifying investment managers that can deliver net outperformance over a long-term investment horizon is difficult. You can look at performance, of course, but data will only get you so far. After all, yesterday’s winners aren’t necessarily tomorrow’s.
In fact, it can be quite the opposite – our 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 market3. So it’s clear that building a successful active strategy isn’t all about the numbers.
We believe success in active stems from a combination of qualitative factors 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 that we can look out for. These fall into four different categories: firm, people, philosophy and process.
Four pillars of assessment
In respect of the firm, we look for organisational structures that are aligned with shareholder interests, as well as a firm’s ability to attract, retain and motivate talented investors. When assessing the people behind the firm 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. We look for managers with a distinctive and enduring investment philosophy that is executed with proven and disciplined processes steered by proprietary research.
Above all, clarity in the investment objective and the process is critical. Managers must be capable of providing a concise and credible explanation of how they intend to generate long-term alpha for shareholders. Even if past performance data is strong, the inability to provide a simple and clear answer here should be a red flag for any investor choosing an active manager.
Diversity of thought
Our 20-strong Oversight & Manager Search team is dedicated to finding managers that make the grade across our four pillars of assessment. They also monitor the managers chosen to run our active funds. This includes the internal talent selected to run our active mandates – Vanguard’s Fixed Income Group and Quantitative Equity Group – which are held to the same high standards as our external partners.
The rich diversity of thought and ideas that comes from working with talent, both internally and externally, is a key facet of our active funds’ success. We don’t pursue difference to stand out, neither do we pursue performance for the sake of it. Our approach to active management is constantly evolving but it is always shaped by the aim of helping our clients to achieve investment success.
To hear from Dan and the portfolio managers driving Vanguard’s active fund range, register for our upcoming virtual active investor conference and connect with the experts. Click here to find out more.
1 Active risk or tracking error refers to the volatility of an active fund relative to the target benchmark.
2 Lipper, a Thompson Reuters Company. Data between 1 January 2010 to 31 December 2020. Data refers to the percentage of Vanguard(R) funds globally that outperformed the average return of their peer group of mutual funds. For the ten-year period, 7 of 7 Vanguard money market funds, 38 of 44 bond funds, 6 of 6 balanced funds, and 30 of 37 stock funds, or 81 of 94 Vanguard funds outperformed their peer group averages. Results will vary for other time periods. Only funds with a minimum quarter-, one-, three-, five-, or ten-year history, respectively, were included in the comparison. Note that the competitive performance data shown represent past performance, which is not a guarantee of future results, and that all investments are subject to risks.
3 Vanguard calculations, using data from Morningstar, Inc. Equity funds’ returns in excess of their prospectus benchmark between the crisis period ranging from 11/2007-02/2009 (global financial crisis) and the subsequent bull market ranging from 03/2009-01/2020. Active equity funds available in the UK were considered. Returns are calculated in GBP net of fees, gross of tax, with income reinvested.
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.
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.
The information contained in this document is not to be regarded as an offer to buy or sell or the solicitation of any offer to buy or sell securities in any jurisdiction where such an offer or solicitation is against the law, or to anyone to whom it is unlawful to make such an offer or solicitation, or if the person making the offer or solicitation is not qualified to do so. The information in this document is general in nature and does not constitute legal, tax, or investment advice. Potential investors are urged to consult their professional advisers on the implications of making an investment in, holding or disposing of shares and /or units of, and the receipt of distribution from any investment.
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