Be it how hedge fund returns have been struggling over the past year or how index funds have been gaining some traction, there has seemed to be much in the financial media over the past few weeks about the challenges facing active management. This certainly isn’t the first time we’ve seen people calling for the end of active management, only for those calls to be wrong.
Yes, we have seen passive strategies gain in certain sectors of the financial markets, but this only creates more opportunity for the active strategies that remain. We certainly don’t envision completely going to a model of all investments being held in index-based vehicles, or computer algorithms dictating how we allocate money. There is a place for the human element, actual people looking into a security and doing fundamental work to see if there is value, as they compile a portfolio they expect will outperform the market. We don’t believe that markets are completely efficient, nor are investors completely rational; rather, there are going to always be some dislocations and opportunities for active investors to capitalize upon, and as there are fewer people pursuing those dislocations, we would expect to see a better opportunity for gain.
Furthermore, we also believe some markets are better suited for active management than others. Yes, there are certain areas of the large-cap equity market that are VERY widely followed and where lower cost passive strategies may make more sense. However, in an area like high yield bond and loan trading, we believe this market lends itself much better to active management. Keep in mind that high yield debt trading is more complex, and it can be harder to find and source product, which can give certain managers an advantage.
Additionally, not every name is widely followed. For instance, many of the largest funds and institutional players focus more on larger issuers and the largest passive ETFs in the high yield bond market have size restrictions forcing them to primarily invest in securities over a certain tranche size, eliminating a large portion of high yield issuers. Our experience over the years has been that we have often found some of the most attractive opportunities in this sector of the market often abandoned by many. And keep in mind that if ETFs, mutual funds, insurance companies, and private funds weren’t stepping in to buy these companies that may not meet the index-criteria of certain products, there would be a large portion of the market that would not have the capital they need to run and grow their businesses.