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How do active managers add value to the investment process?

September 1, 2017 | Commentary

  • The debate about active versus passive investing is often carried out on a superficial statistical level where the focus is on who has earned higher returns lately. A more fundamental question should be how it is possible for active managers to add value.
  • There are only three broad avenues to added value: 1) having superior information; 2) seasoned judgment and analyzing public information with better models or technology, and; 3) managing investments with lower costs.
  • A fourth element of trading success comes from taking advantage of other participants in the marketplace who either fall prey to emotional mistakes or are forced into trades because of liquidity concerns. This is again judgment in the form of relative trading skill, which may or may not be repeatable in all environments.
  • When evaluating whether an active manager has a good chance of outperforming in the future it is critical to find the sources of past added value. It may never be possible to conclusively separate skill versus luck, but by doing a deep dive into past attribution and not relying solely on return numbers, investors improve their odds of associating with managers who have the best chance of long-term success.

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