Active managers use
a forward-looking orientation in their stock analysis and investment process
as they believe it gives them an important edge over backward-looking indexes, which favor stocks
that already have performed well. Active managers can evaluate their positions to “buy low” and
“sell high,” while passive investors will always effectively buy more of the stocks and sectors that
have increased in price the most and will be increasingly underweight those that have performed
the worst. Momentum investors will essentially do the same. This works well in rising markets
with clear, easy-to-follow trends. However, when markets display less prominent trending,
investors risk suffering sharp losses as mean reversion kicks in. Interestingly, we believe the
increased popularity of ETF investing, currently 30% of the daily trading volume (as of August
2010), has created even greater inefficiencies for active managers to exploit going forward
(Exhibit 4). As ETFs drive an increasingly larger percentage of equity trading volumes, stock
prices are determined by non-company specific, technical factors and less by fundamental
factors. This can lead to excellent entry and exit points for fundamentally-driven investors.
Greater value of active management during periods of lower returns
Active managers tend to outperform when the markets are down or in a trading range
We believe active managers outperform the index over time
