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What It Pays to Be ProActive
Kristof Gleich, President, CIO, Harbor Capital Advisors
First, a health warning. This month’s update is quite data intensive. I’m trying to answer the seemingly simple question of “How did Active Management do in 2020?” When I Google search “active management in 2020 review,” surprisingly little comes up. There are a few articles from around midyear that suggested the volatility of 2020 gave active managers the opportunity to shine. The question is— “Did they shine?” The answer in my opinion, overall, is yes.
The first chart on this topic that caught my attention was from J.P. Morgan in mid-December. Their quant group published a chart that suggests that active management had its best year since 2009, and that last year made up for the four prior years of active managers’ underperformance. Is this true? By their measure, yes. They created a quite logical, albeit not commonly used, measure of how to illustrate this conclusion. They built a giant composite of domestic and international funds versus an S&P 500/MSCI AC World Index proxy, which shows, in aggregate, how this was accomplished. Their findings suggested strong annualized alpha, overall, at a level we have not seen since 2009. I think this is a reasonable starting point, but further research is necessary, so we need to pull on this thread a little more.
There’s no single metric to judge whether active managers have been successful or have failed as a group—though I think the above chart, as a single metric, does a pretty good job. Generally, the popular press focuses on the percentage of active managers that outperform or underperform, net of fees. I think this is somewhat helpful as an input, but on its own, it’s incomplete. To round this out more fully, we need to consider by how much good managers outperformed. How much did winning managers win by, how much did losing managers lose by, and what did the results show, as a whole?
If we look across equity and fixed income asset classes, we can examine how many managers outperformed—and by how much the winning managers beat the losing managers—and then, compare the results to the long-term average. Below we show this trend.
Each “dot” is an asset class from Morningstar—the blue dots are the 2020 data points, and the grey dots are the long-term average for each Morningstar category.
2020 was unusual in that we witnessed a much larger dispersion between winning managers and losing managers versus long-term averages and expectations. While this wasn’t true in every single asset class, it was true on average.
Peeling back another layer from the onion, we can take the above anonymous asset classes and reveal which ones they are, and what conclusions we can draw.
We have split the data into asset class categories (and by style within the U.S). The data tells a very clear story. In domestic investing, there was a very large dispersion between active managers’ returns in growth investing, large(ish) dispersion in blend, average dispersion in value. Overseas markets, when applied to foreign, global or emerging markets, resulted in large dispersion. The story in fixed income was a little more average (except for convertible bonds). In the Appendix for each of these asset classes, we have shown how this year compares to each calendar year for the past 20 years. You can squint across the charts yourselves, but across the major groups, dispersion was high. Anyone who uses active management in their portfolios in any meaningful way—in growth investing or international investing (and to a lesser degree, blend or core)—probably experienced outsized returns relative to their own expectations or history.
For the rest of this review, we’ll stay focused on equities, as we ask ourselves why this was happening.
In order to do this, we looked at a few different things. My starting premise is that active managers don’t change much, year on year. Their behavior (more or less) stays constant or at least consistent— therefore, it’s more likely that they stayed consistent as a group, but still, something changed around them.
First, we looked at stock correlation. Correlations generally measure how things move in the same direction…or not. I originally thought that perhaps stocks exhibited unusually low correlations in 2020, giving managers the opportunity to differentiate themselves from one another. Not so. Correlations weren’t low—in fact, stock correlations in 2020 were among the highest on record. In the table to the right, for each index, you can see where 2020 ranked against their own history. This high correlation was likely dominated by the record sell-off, and then recovery, that we saw in equity markets in 2020.
However, correlation doesn’t capture magnitude; it only captures direction. To determine magnitude, we looked at the distribution of stock returns within each index, compared to the annual average over the last 35 years. Perhaps there were more outliers in the tails? I caught the scent of this trail when analyzing our managers, especially those who had outsized returns for 2020. If we look at the Russell 3000® Index, you can see that the righthand “home run” tail is larger than average, meaning, there was a better chance of hitting home runs. We looked at the annual stock return distribution across all major indices and have included the data in the appendix, so you can decide for yourself. But it certainly seems that the home run bucket across different markets was consistently larger than normal. Perhaps this gave managers, who capitalized on this phenomenon, the opportunity to earn outsized returns relative to average years.
When we look inside our portfolios at what outperformed this year and led some of our managers to have outsized returns, the general theme is that those managers held “disruptors.” In some cases, these “disruptors” have been quite long-term holdings and appear across many different sectors; however, the common thread across them is technology. Therefore, technology-oriented stocks appeared to drive outperformance across managers—whatever their geographical area, style orientation, or whether those stocks were actually classified as technology by industry categorization.
Active Managers, in aggregate and based on the data provided, appeared to deliver in 2020—though no single silver bullet or factor describes exactly why.
After a deep dive into the data, I discovered the following:
- The dispersion between winning and losing managers was as wide as it’s been since the 2000 dotcom bubble burst. This was not universally true, however, but on average it was. This effect was especially pronounced in growth investing and international investing, where alpha was disproportionately large as a percentage of overall return.
- Correlations ran historically high, which normally runs counter to active management doing well. This was perhaps offset partially by a higher proportion of “home run” stocks than in normal years.
- Looking at our individual managers, technology-oriented stocks and positioning played a very important role in deciding outcomes. More broadly, stocks in any sector—where they were on the right side of technology, disruption, or change—had an outsized impact, compared to previous years.
Annual dispersion across U.S asset classes
Annual dispersion across Foreign and International asset classes
Annual stock return “buckets” versus long-term history
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All charts and data are for illustrative purposes only.
The views expressed herein are those of Harbor Capital Advisors, Inc. investment professionals at the time the comments were made. They may not be reflective of their current opinions, are subject to change without prior notice, and should not be considered investment advice. The information provided in this presentation is for informational purposes only.
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