Finding the Pockets of Opportunity for Active Management | ETF Trends

Recent reports have shown that active management doesn’t outperform as often over longer time horizons, but there are specific areas where active managers and active funds can and do shine. Benchmarks are beat with much higher frequency in small- and mid-cap investing, investing in overseas markets, and in intermediate-term bonds, reports Kiplinger.

In more saturated market spaces, such as large-caps, competition is a lot greater and it is harder for funds to set themselves apart, particularly when they are pulling from the same securities as most other funds in the space. Indeed, in large-cap investing, only 17% of active funds beat the S&P 500 benchmark over a 10-year period that ended in June of this year, as shown by data from S&P Down Jones Indices.

“Areas of the market that are less picked over are more target rich for active fund managers,” said Ben Johnson, director of global ETF research at Morningstar. “There’s less opportunity if you’re coming up with the 12 millionth investment thesis for Apple.”

Smaller-cap companies tend to be less invested in, and the space is less trawled by some of the major asset management firms. It tends to provide a space to identify innovation and to seek out high potential investments that are just beginning their upward trajectory, and small- and mid-cap investing provides good opportunities for active managers.

“It’s almost like deep-sea diving,” said Johnson, adding that as investors move down the chain from large-cap to small-cap, “the murkier it gets and the fewer predators there are.”

Active managers are constantly on the lookout for what they believe to be “inefficiencies” in which a company is undervalued by markets, according to Brian Price, head of investment management for Commonwealth Financial Network. These companies might have strong fundamentals or good growth indicators, and investing in them at value prices can provide great return potentials for investors.

Mid-cap companies tend to be some of the most overlooked as they “lack the excitement of small companies and the name recognition of large names,” said Craigh Cepukenas, co-manager of small- and mid-cap funds at Artisan.

Investing internationally also provides great opportunity for similar reasons: The markets and companies contained within them are often less known in the U.S., and active managers have a chance to have a leg up by having “boots on the ground” in the countries they are investing in, according to Dan Genter, CEO and CIO of RNC Genter Capital Management. By visiting the companies and working with local agents, active managers are able to have a better grasp on the drivers of markets and the local economics and therefore are able to outperform the benchmarks more often.

In the Active/Passive Barometer report from Morningstar, bargain-priced stock pickers tended to perform the highest in foreign markets compared to indexing peers.

Bonds are another major space that active managers generally outperform in and which active management lends itself to. Because active managers are able to dig into the quality of the debt instruments within the bond spaces, they are able to avoid investing in bonds that have lower quality but might be contained within the index that passive funds follow.

Also, the ability to tilt a portfolio towards sectors with higher yield has provided great success for active funds in the intermediate bond space particularly. By investing in some of the lower-rated corporate debt securities, or those securities that are asset-backed and have higher yields, active funds can potentially outperform the Bloomberg U.S. Aggregate Bond index, says Price of Commonwealth Financial Network.

Active management firm T. Rowe Price offers eight different actively managed ETFs with a variety of investment strategies within equities as well as bonds. The firm brings a bevy of experience and research to its products, with portfolio managers averaging over 20 years in investing each, as well as over 400 investment professionals dedicated to researching companies within ETFs.

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