The bear market puts active management back in the spotlight


With the historic 11-year bull market now officially over, actively managed funds should be licking their chops at the chance to stand out in the market pullback by picking winners from the rubble.

It’s the theory and argument that proponents of active management often cite when faced with the challenge of competing with cheap index funds during a bull market.

In practice, since the COVID-19 virus began to wreak havoc on global financial markets, active management performance has been mixed at best, according to Morningstar analyst Jeffrey Ptak.

From February 20 to March 16, when the S&P 500 index fell 29.3%, 42% of all active funds tracked by Morningstar outperformed their respective indexes.

This is slightly worse than the 44% of funds that beat their benchmarks during the period from December 24, 2018 to February 19, 2020, which represents the most
recent period of rally from bottom to top.

A deeper dive into the data shows extreme disparity.

For example, 52% of active US equity funds beat their benchmarks in the recent downturn, compared to about 29% that beat their benchmarks in the rally that ended Feb. 19.

Then there is the other extreme of international equity funds, 30% of which beat their benchmarks in the recent downturn and 61% beat their benchmarks in the rally that preceded the downturn.

Active taxable bond funds also fell in the recent pullback, just 21% better than their benchmarks, compared to 47% in the market rally.

“It’s a mixed picture at best for investors who have been waiting for active funds to save their fat during the recession,” Ptak said.

Two categories of funds where active managers seem to make a living are alternative strategies and commodity funds.

During the four-week decline period studied by Morningstar, 90% of active commodity funds beat their benchmarks, compared to less than 30% during the previous rally.

Liquid alternative funds, many of which are benchmarked against the S&P 500, also stood out with 85% beating the benchmark during the decline, compared to just 17% during the rally.

Given expectations of a longer-term market decline, it is too early to say that the entire universe of active managers is a winner or a loser. But this clearly
represents a real test for an asset management category that is struggling to stay relevant in the face of a flood of lower-cost index funds.

“In the past, active equity mutual funds have underperformed index alternatives, causing advisors to turn to ETFs linked to the S&P 500 and Russell.
2000 indices,” said Todd Rosenbluth, director of mutual fund and ETF research at CFRA.

“However, if mutual funds are able to justify their premium fees for stock picking, advisors might stop taking money out and stay loyal,” he added.

Coincidentally, the timing of the latest major test for active management comes just as the industry is preparing to roll out the first non-transparent active ETFs, which have mostly been put on hold since the pandemic swept through financial markets.

“Now is a great time for portfolio managers to shine given the planned launch of active ETFs,” Rosenbluth said. “If active management is able to show performance success before a pending launch, that will help.”

Pam Holding, co-head of the equity division at Fidelity Investments, remembers periods of market turbulence dating back to the crash of 1987 and said each presented its own unique opportunities for active managers.

“That’s where we can shine and attract companies that we think are long-term winners,” she said. “From my perspective, every crisis always feels very bleak, and then you walk through it and realize it was an opportunity. That’s what we tell our team.

While market downturns are usually a time for active managers to shine, Morningstar’s Ptak said investors and advisers should always be careful when and where they move from passive to active. , and vice versa.

“Our research found that active funds tend to do better during bear markets, but the problem is that the duration of bull periods far exceeds that of bear periods,” he said.

With an average bull market since 1926 lasting 9.1 years and an average bear market of just 1.4 years, active funds that excel during market downturns typically have less time to strut their stuff. .

This is one reason why active funds, in general, tend to outperform during bear markets less than they underperform during bull markets.

“What the means is that the ground they are able to regain during a bear market is not enough to close the gap created during the bull market,” Ptak said. “But we look at averages, so you need to identify which fund will outperform on a downturn and you need to know when to do that. I don’t know if it’s actionable, but there are some funds that are very determined to avoid the downside.


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