Win by losing? The surprising truth about long-term active management

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2024-04-30
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The views expressed are those of the authors at the time of writing. Other teams may hold different views and make different investment decisions. The value of your investment may become worth more or less than at the time of original investment. While any third-party data used is considered reliable, its accuracy is not guaranteed. For professional, institutional, or accredited investors only.

While many asset owners recognize the value of a long-term mindset, few realize how critical it is to enduring success in active management. Our research shows that the best active managers suffer extended periods of underperformance along the way to top-quartile and even top-decile results. For asset owners, it can be challenging to resist short-term instincts in volatile environments like the one we’ve seen in recent months. But those who have a strategy to help them stay focused on the long term may be best positioned to reap the benefits of outperformance and avoid potentially costly behaviors, including abandoning a thoughtfully selected allocation to a manager after a relatively short period of underperformance.

Signs of resilience in top-quartile managers

Recently, we used the eVestment database to look at the performance of active managers in the global core equity universe who had at least a trailing 10-year history (339 managers, 2013 – 2022). We evaluated their peer-universe-relative 10-year excess return rank (calculated using the MSCI All-Country World Index) to identify the best performers — those in the top quartile or top decile over the full decade. 

As shown in the dark-blue bars in Figure 1, every one of these top-quartile managers experienced not just a “bad year,” but a 24-month period during which they lagged the median manager in the universe. Almost all (86%) did the same over a rolling three-year period and more than half (52%) were below median over a rolling five-year period — half of the time period we studied! 

We also looked at how much of the time these top-quartile managers spent among the bottom-quartile of their peers (light-blue bars). Amazingly, 89% of the top-quartile managers spent at least a year in the bottom quartile, and more than half were in the bottom quartile over some three-year period. In some cases, three years of bottom-quartile performance is enough to get a manager put on a watch list and fired, even though that’s probably not what you want to do with a manager that will end up in the top quartile.

Figure 1
Spreads historically widen following crises

Remarkably, the same pattern holds for top-decile managers, the “cream of the crop” in the same global core equity universe. Each top-decile manager was below median over at least one two-year period (Figure 2). Nearly three quarters (73%) were below median over a three-year period and close to half (45%) over some five-year period.

Nor were the top-decile managers immune from spending time in the bottom-quartile “dog house.” Many spent a year or two there (85% and 73%, respectively). More than half (52%) spent three years in the bottom quartile and nearly a quarter (24%) spent half of the decade in the bottom quartile, even though they finished in the top tier.

Figure 2
Historical issuance volumes show sharp increase following volatility

Importantly, we ran the same analysis for all active global core equity managers present in the market during an earlier 10-year time period (2006 – 2015) and found very similar results — suggesting that the near-term underperformance of highly skilled managers is likely a persistent phenomenon and not, say, a unique aspect of the COVID era.

Cultivating a long-term mindset

Asset owners (and sometimes their boards) invest enormous time and effort in selecting managers. We think the data above shows that those who believe they have found a winning manager should think twice before abandoning their conviction just because a manager has a bad run — even, potentially, an extended bad run. The art of long-term manager assessment is a bigger topic than we can cover here, but we believe asset owners should look for managers who approach periods of underperformance by balancing conviction in their core philosophy and process with a degree of humility and an openness to testing or revisiting their assumptions and beliefs. Of course, the more managers can help asset owners understand (ahead of time) the kinds of environments in which they will struggle, the better off both parties will be.

For more on this topic, including strategies to help cultivate a long-term mindset, read our recent paper here.

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