Publisert: 31.05.2017, 13:35
I dette blogginnlegget deler jeg en tre siders besvarelse fra utvekslingen i Frankrike. Innholdet ble skrevet og levert inn i april 2017 av undertegnede. God lesning!
This paper is an assessment in Portfolio Management at EMLYON Business School. By looking on existing theories, we see that modern portfolio theory argues for passive management and behavioral portfolio management argues for active management. Then when we look at empirical studies on how all mutual funds perform in practise against index funds, and see an underperformance with negative alpha trend for the mutual fund managers. This mean that index funds should be preferred, but again we also see that some portfolio manager delivers significant positive alpha year after year. So, there is some deviation from the normal manger trend, but if this is due to good timing and selection abilities or just pure luck, we still do not know for sure. Professors from different universities in Norway have for example argued that this is pure luck, and have said on Norwegian television that investors should invest more in index funds in the future if they just want to increase their wealth over the long haul.
This short paper is a 25% part of our grade in GF27A Portfolio Management at EMLYON Business School and I will here discuss passive versus active fund management. I wish to thank our course supervisor, Eric André, who have given us useful theories during the course and good articles to build this assignment on.
This topic was hot in the Norwegian media in 2015 and is still an important question to answer, since many still choose active funds management – 89 percentage in Norway – all over the world (PwC, 2014) and Norwegian people can now choose where and how to invest their pension capital (Håpnes, 2015). In addition, there have been low returns on real interest rate after taxes the last years, making people to look on other options to save money and at the same time get a profit out of it. We also see that the Government Pension Fund of Norway is actively managed and pays a lot in bonuses to the different portfolio managers. The question is, do active fund managers deliver significant alpha values higher than their net prices compared with index funds?
My interest for this topic is huge, since I have considered and still consider to be a portfolio manager. But I do not want to be mutual fund manager if it is not possible to deliver higher values than the index funds for the investors. This meaning that the mutual fund minus fees (investors costs for actively managing the fund and sometimes also transaction costs), delivers a return that are higher than the index fund return. If the active funds underperform and deliver negative alpha, we should shift from mutual funds to index funds.
To understand this topic more, I wrote my bachelor thesis about passive versus active funds management (Håpnes, 2015). Back then I wanted to see if three mutual funds could outperform the market and deliver alpha. The results from the analysis was that Odin Norge and Alfred Berg Norge had delivered higher information ratio and sharpe ratio than the market index, but they did not have significant alpha values. Storebrand Norge delivered lower information ratio and sharpe ratio than the index, and had not a significant alpha value. I also looked at the timing characteristics of these funds, which was all significantly negative, and this finding is not surprising if the market is strong efficient. Then looking at the selection properties, all showed positive values, but only Odin Norge had a significant value. Although the selection value of Odin Norge was minimal, this indicated that the market is not one hundred percent efficient.
To have a common understanding of these two different types of fund management strategies, we need a definition of them:
· “Active management: improve performance either by identifying mispriced securities or by timing the performance of broad asset classes.
· Passive management: hold highly diversified portfolios, do not spend resources attempting to improve investment performance through security analysis” (André, 2017A). There are different types of mutual funds that for example focus on sectors, countries, firm-size, and so on. It is also ideal for those who favour a hands-off approach and have neither the expertise nor inclination to educate themselves on market nuance (CNBC.com, 2015).
The Capital Asset Pricing Model (CAPM) is the single-period model that argue for passive management (André, 2017B). CAPM are built on different assumptions like no transaction costs, no taxes, that investors are mean-variance optimizers and have homogenous expectations. This model is also built on the assumption of Equilibrium in Capital Markets, like the Arbitrage Pricing Theory that is built on the CAPM, but have less strict assumptions. An arbitrage is a trading strategy that gives a certain profit with no initial investment. This mean that if there is no arbitrage opportunity, the prices are correctly priced.
Market efficiency is about assets prices reflect all available information (André, 2017C). Samuelson (1965) argued that prices are unpredictable and adjust meaningfully only with the arrival of new information, called random walk. Fama (1970) presented three different forms of market efficiency; weak form with all security market information, semi-strong form with all public information, and strong form with all public and private information.
According to Bill Miller, the legendary stock picker at Legg Mason Capital Management who beat the Standard & Poor’s 500 Index for 15 consecutive years, says that active funds are expensive and closet indexers (Bloomberg, 2016). This mean that mutual fund managers have a huge share close to index, and have just a little share that is active, since they promise to perform close to their index and outperform it. Thus, active fund managers do not produce net results that perform better than the average passive fund because their fees are much higher. In addition, Goldman Sachs says that low return dispersion and a stock market selloff combined, makes life hard for active investment managers (Bloomberg, 2015).
Behavioral Finance is an alternative to Modern Portfolio Theory (CFA Institute, 2013). According to CFA Institute, Behavioral portfolio management is aimed at building superior portfolios based on the pricing distortions created by investor’s emotional behavior. The core of Behavioral portfolio management focuses on the specifics of how to build portfolios based on behavioral factors. The portfolios are built to reduce the emotional impact of volatility, by dividing the investor’s portfolio into a percentage to build long-term wealth and a percentage to meet short-term needs. Behavioral Finance criticizes the rationality assumption and argues that there are limits to the possibility of arbitrage (André, 2017D), but it still retains the statistical analysis of historical data. According to C. Thomas Howard, who have rejected the Modern Portfolio Theory (MPT), there are a lot of evidence against MPT, but many academics sticks to it anyway (CFA Institute, 2013). He means that this professional decision is emotionally driven and should be rejected in an ideal world.
Sørensen (2010) concluded in his doctoral dissertation that Norwegian mutual fund managers as a group fail to beat the market to deliver positive alpha when controlling for systematic risk. The statistical tests show clear signs of incapacitation at risk-adjusted excess return, and few signs of skills. At the same time, he calls for multiple investment opportunities in index funds that are cheaper than actively managed funds.
The S&P Indices Versus Active (SPIVA) scorecard, which measures the performance of actively managed funds against their respective benchmarks, found that 87 percent of large capitalization fund managers underperformed the S&P 500 Index over the last five years, and 82 percent failed to deliver incremental returns over the last decade (CNBC.com, 2015). Similarly, Northern Trust Wealth Management found that 84 percent of actively managed domestic mutual funds, regardless of market cap, underperformed their respective benchmarks between December 2004 and December 2014.
A master thesis from NHH also concludes that some mutual fund can point to outperformance, but that the overall will not pay off with an active management strategy (Grønsund & Lunde, 2010).
These empirical findings are representative for most of the studies in developed countries of this century.
Mutual fund managers must assume that there are possible to find underpriced or overpriced assets, and that they can find right price and do this better than the other investors. If this is possible is almost an impossible question to answer today, but if we look at the historical excess returns there is a sign of negative alpha performance for almost every active fund manager. But there are some managers like Bill Miller and Warren Buffett that outperform the market and they are an exception within the overall performance trend. The big question is if this is luck or not?
Professors from different universities – Espen Sirnes from Tromsø and Ola Kvaløy from Stavanger – in Norway did on television in 2016 argue that this was pure luck (NRK, 2016). An example of this is if you throw a Norwegian crown. You should expect to get 50 percentage of managers performing better than index and 50 percentage that underperform this year. Next year 50 percentage of the outperforming managers will again perform at better than index, but 50 percentage will perform worse than index, and so on the coming years. This is something that they showed true ratings made by Standard and Poor. Bill Miller delivered alpha over 15 years, but after this the luck was over. The probability to do this over 15 years is 0,003 percentage, a low probability, but this is still bigger than winning in the lottery Eurojackpot. Thus, this is an argue that how a mutual fund performs from one year to another is random and you cannot look at historical data, and confirm what Katie Nixon, chief investment officer of Northern Trust Wealth Management, said (CNBC.com, 2015).
Another problem is that many of these amazing stars do you don´t see before they perform well over many years, and when you first invest in them they can show up to just be one of the lucky dice throwers and all your wealth decreases. So, it is easier and less risky to invest in index funds than to find an alpha performing manager.
To sum up, active or/and passive fund management depends on your own belief about the market and why you invest. There are strong signs towards passive fund management, but there is also people that argues well for active management. Maybe you are the next investment guru or invest your wealth in the next investment guru that outperform the market over many years with luck or not. This gives you a significant positive alpha and in the end, you as an investor almost only care about getting the highest possible return from your invested wealth. I personally would recommend investing more in passive managed funds.
The weakness of this paper is that undeveloped countries are not included. These markets can be inefficient, but this is not a topic here. The same for a market when it crashes, but I will live this to further research. The last important thing to remember is that all these theories and models is just a simplification of reality, but some can be useful (André, 2017E).
· André, E. (2017A). PowerPoint: Introduction. EMLYON Business School: Portfolio management.
· André, E. (2017B). PowerPoint: Equilibrium Models. EMLYON Business School: Portfolio management.
· André, E. (2017C). PowerPoint: Market Efficiency. EMLYON Business School: Portfolio management.
· André, E. (2017D). PowerPoint: Behavioral Finance. EMLYON Business School: Portfolio management.
· André, E. (2017E). PowerPoint: Applications. EMLYON Business School: Portfolio management.
· Bloomberg (2015). Goldman Sachs Has Some Bad News for Investors Who Like to Pick Stocks.
· Bloomberg (2016). Shift From Active to Passive Investing Isn’t What It Seems.
· CFA Institute (2013). Behavioral Portfolio Management: An Alternative to Modern Portfolio Theory.
· CNCB.com (2015). Passive investing is profitable, but there's a time to get active.
· Fama, E. F. (1970). Efficient capital markets: A review of theory and empirical work. The journal of Finance, 25(2), 383-417.
· Grønsund, N., & Lunde, K. (2010). Aktiv forvaltning av norske aksjefond (Master's thesis).
· Håpnes, D. (2015). Passive versus active funds management – A performance analysis of three mutual funds. Nord-Trøndelag University College.
· NRK (2016). Folkeopplysningen: 2. Økonomiekspertene.
· PwC. (2014). Asset Management 2020: A Brave New World.
· Samuelson, P. A. (1965). Proof that properly anticipated prices fluctuate randomly.
· Sørensen, L. Q. (2010). Essays on asset pricing. Bergen: Institutt for foretaksøkonomi.