(December 11, 2012) — Most active managers are dysfunctional at best, according to a report by consulting firm Hewitt EnnisKnupp.
The report, titled “Conviction in Equity Investing,” found that the disfunction of the industry is caused by behaviors of managers, plan sponsors, and consultants. Furthermore, the paper alleged that asset owners lack conviction–or the willingness to take risk and express beliefs through a bold course of action, in pursuit of long term goals–while avoiding risk. “The only group of managers that demonstrate skill are highest conviction high active risk approaches,” Michel Sebastian, a partner at Hewitt EnnisKnupp told aiCIO.
Pointing to why active management is largely unreliable, the paper asserted that 98% of active equity managers fail to demonstrate skill. Even more alarming, skill has steadily declined over 20 years as manager conviction and willingness to take risk have deteriorated, encouraged by consultants, Sebastian noted.
Why are consultants largely to blame for the deteriorating state of active management? “Consultant buy-lists are much too large and contain strategies that are doomed to fail,” Sebastian noted.
“It is widely accepted today that the average traditional active manager underperforms the benchmark–since active managers and index funds together are the market, together they must earn the return of the market, and active management involves higher fees and trading costs that drag down average return,” Hewitt EnnisKnupp’s paper said. “Therefore, success with active management is dependent on proactively identifying the best managers through careful research.”
Therefore, the solution to saving a dysfunctional industry, according to Sebastian, is for asset managers, plan sponsors, and consultants to commit to taking a higher level of risk. Many plan sponsors will be better off indexing their whole portfolios, and many investment managers may be better off going out of business, he said.
On a more optimistic note, a paper by Wellington Management released last month revealed that active managers have struggled amid a turbulent economy, but that the tough ride for these managers may have reached an inflection point.
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