A Golden Era for Active Equity Management

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In our 2019 book, Return of the Active Manager, Jason Voss and I declared that active equity management was alive and well in spite of the movement to index investing. We provided numerous suggestions to improve the evaluation of investment opportunities as well as manage equity portfolios, from the perspective of behavioral finance.

Little did we know that a golden era of active equity management would commence shortly after our book was published.

Active versus passive

This article is an update of my 2020 Advisor Perspectives article, The Dawn of a New Active Equity Era. In that article, I discussed the surprisingly positive impact of the active to passive flows on the prospects for active equity outperformance. The flows out of closet indexers and into true indexers is creating an attractive active equity environment. I will not repeat the evidence supporting this argument.

Active equity opportunity

In the previous article, I described a measure, dubbed active equity opportunity (AEO), which reveals how favorable markets are for stock picking. Markets characterized by high individual stock dispersion and high positive skewness, high market volatility, and small cap outperforming large cap set the stage for stock picking success. Active equity managers prefer a higher AEO since it indicates their high-conviction picks are more likely to outperform. On the other hand, a low AEO implies that even the most talented managers will struggle to beat their benchmark.