Active and Passive: The Best Mix

mix tape cassetteUndeniably, traditional active management has been losing market share over recent years. Bottom-up stock pickers are faced with increasing competition from new beta-based approaches. Enhanced Indexing or smart beta terminology aside, the basis of this shift is entrenched in the argument that factor-based models add returns at a significantly lower cost than the traditional active manager. Andrew Flynn, CFA, partner, and co-portfolio manager for the William Blair International Small Cap growth and Global Leaders strategies, explains.

“Historically, fundamental managers have focused too much on outperformance rather than risk,” he says. The result is an overall industry that has delivered mediocre performance, especially when considering the volatility of returns and – as investors will inevitably remind you – fees. Flynn explains that a combined approach of conventional active, fundamental stock selection and the incorporation and understanding of factor exposures is superior to either a purely fundamental or purely factor-based approach.

“High quality stocks have always held a premium over low quality ones – but, post-2008, investors are now paying very high prices for value,” he explains. “Slowing global growth has led people to migrate to companies that can execute strategies and grow earnings nicely. Investors today favour reliable corporate performance at the expense of everything else.”

Flynn cautions that, as expensive stocks take on a more influential role in indices based on momentum, value and volatility factors, the market will revert, pushing pure passive investors into the red.

An integrated approach allows for an objective, unbiased discipline of a systematic approach, and experienced-based oversight of a pure fundamental manager. Flynn adds that a contemporary approach to combining traditional fundamental and systematic methodologies can result in superior risk-adjusted returns through market cycles, and downside protection in times of disruption.