2017 Could be the Year of the Active Manager

February 10, 2017 | Active Management

It has been said that those who do not learn from history are doomed to repeat it. With the value of active management called into question in recent years, we are compelled to consider our history to see what we might be able to glean about the realities of today’s environment.

Active managers have come under fire during the market recovery that started in 2009. Many failed to keep up with their benchmarks as markets rallied. If history is any indication, however, this underperformance may have reached a bottom. A recent chart that appeared in the Wall Street Journal shows active management could be ripe for an upturn.

We’ve Been Here Before – Each Trough Has Been Followed by Recovery1

Percentage of Funds (Fund Assets) Outperforming S&P 500 on a Five Year Basis(01/31/1970 - 12/31/2016)

As the numbers demonstrate, today’s underperformance relative to the benchmark may not be so unique after all. Let’s take a deeper look at some of the periods on this chart and how Manning & Napier fared during these times.

Greed in 1987

Throughout 1987, Manning & Napier steadily decreased equity exposure in client portfolios as stock markets climbed higher. Although we were criticized for missing the continued bull market, we stuck to our belief that stocks were overvalued based on their underlying fundamentals. Our Long-Term Growth strategy trailed its benchmark in seven of the twelve quarters preceding the fourth quarter of 1987; however, in October of that year, the stock market crashed and the S&P 500 fell 22.5%. Our commitment to fundamental value, which sacrificed returns during the latter stages of the bull market, positioned our clients to weather the downturn. Long-Term Growth went on to achieve strong absolute and relative returns over the next several years.

Fear in 1990

From a war with Iraq to an oil price spike, markets experienced a series of shocks in 1990. The stock market dropped more than 13% in the third quarter of that year, and the U.S. economy subsequently fell into a recession. Our Long-Term Growth strategy lagged its benchmark over several time periods by the end of September. Despite the turmoil, however, we maintained equity exposure based on our long-term outlook. This discipline paid off as Long-Term Growth produced strong absolute returns that outpaced the benchmark throughout the early ‘90s.

Irrational Exuberance in the Late 1990s

By mid-1995, Manning & Napier began to grow concerned about the greed in the market. Instead of pursuing the hot tech companies of the time, we sought opportunities in foreign equities and mid-cap stocks. Then, in August 1998, the U.S. stock market fell by more than 14% as the Asian financial crisis unfolded. Our reluctance to hold U.S. large cap stocks, coupled with exposure to foreign equities, led to our Long-Term Growth strategy experiencing almost double the decline of its benchmark in the third quarter of 1998. Once again, we stuck to our portfolio positioning, and our returns well exceeded benchmarks over the next one, three, and five years following September 1998. Remaining focused on fundamental value ensured our clients’ assets were well positioned during the severe price correction that ensued.

Each of these case studies provides an example of the value of active management in specific scenarios, but what if we look at a longer (and more recent) time period? After all, performance results are most meaningful over full market cycles – i.e., through a bear market, subsequent recovery, and eventual bull market. The chart below illustrates the value the Long-Term Growth strategy has provided vs. its benchmark over the current U.S. stock market cycle, which represents both good and bad markets.

Growth of $10,000: Over the Current U.S. Stock Market Cycle (04/01/2000 - 12/31/2016)

Despite the variety of market environments we face, remaining selective and active is a central tenet of our investment philosophy. Today, we are seeing a significant number of sentiment-driven trades in the market, with the Fed reportedly set to continue raising interest rates. History has shown that sentiment-driven markets cannot continue indefinitely, and periods with rising rates generally lead to lower correlation and a larger spread between the best and worst performing stocks, all of which can favor active management. In this type of climate, active strategies tend to outperform, as shown in the chart below.

Outperformance of Active Funds vs. Interest Rates2

U.S. Active Fund Excess Return vs. Rate Environment (01/31/1962 - 12/31/2016)

If active managers can take advantage of the current environment and remain focused, they could be on the brink of yet another upturn.

Active managers like Manning & Napier try to help investors reach their goals while managing risk along the way. We look at fundamentals, valuations, and the competitive strengths and weaknesses of potential investments. Indices, meanwhile, are based on quantitative metrics like market capitalization in stocks, or bond issuance volumes in fixed income. Our differentiated methodology explains why there are times when active management dramatically outperforms, or why there are times, as in recent years, that we appear out of favor. We’ve been here before, and we’ll be here again. When we take into account both history and the current environment, we believe being an active manager today is critical for long-term success.

The S&P 500 Total Return Index is an unmanaged, capitalization-weighted measure of 500 widely held common stocks listed on the New York Stock Exchange, American Stock Exchange, and the Over-the-Counter market.

The Long-Term Growth strategy performance provided is that of the Manning & Napier Long-Term Growth Composite, which is a weighted average of discretionary separately managed accounts, and may include proprietary mutual fund and collective investment trust fund accounts with a Long-Term Growth objective. Accounts in this composite must have a market value greater than $500,000 and tenure of at least one year under our management. Long-Term Growth is a blended investment objective that invests in equities, primarily U.S. with some non-U.S., and fixed income securities. The primary investment objective of accounts in this composite is long-term growth, and the secondary objective is preservation of capital. Equity exposure for accounts in this composite typically ranges from 30% to 80% with situational adjustments within this range at our discretion. Net-of-fee returns are calculated based off of the effective fees of the accounts in the composite. They are after brokerage commissions, reinvested income, and advisory fees, but if applicable, before custodian costs and the fees of the investor’s Personal Financial Advisor. Also, accounts subject to solicitation fees may incur as much as 0.15% in additional expenses. Fees will vary with size and circumstances and these fee differentials would impact returns accordingly. Past performance does not guarantee future results. Prior to 01/01/2009, proprietary mutual fund and collective investment trust fund accounts with a Long-Term Growth objective were excluded from the composite. This composite includes separately managed accounts that may have a portion of their assets invested in proprietary asset class mutual funds, which may be declined or may not be permitted through the selection of some custodial programs. All data are subject to revision.

Due to the active allocation process, actual allocations may vary from benchmarks. These are unmanaged mixed-asset class benchmarks. Benchmarks shown are a weighted blend of the respective indices. The 40/15/45 Blended Index is 40% Russell 3000® Index (Russell 3000), 15% MSCI ACWI ex USA Index (ACWIxUS), and 45% Bloomberg Barclays U.S. Aggregate Bond Index (BAB). Russell 3000 is an unmanaged index that consists of 3,000 of the largest U.S. companies based on total market capitalization. Index returns are based on a market capitalization-weighted average of relative price changes of the component stocks plus dividends whose reinvestments are compounded daily. Index returns provided by Bloomberg. ACWIxUS is a free float-adjusted market capitalization index that is designed to measure equity market performance in the global developed and emerging markets and consists of 45 developed and emerging market country indices outside the U.S. The Index is denominated in U.S. dollars. The Index returns are net of withholding taxes. They assume daily reinvestment of net dividends thus accounting for any applicable dividend taxation. Index returns provided by Bloomberg. BAB is an unmanaged, market value-weighted index of U.S. domestic investment-grade debt issues, including government, corporate, asset-backed, and mortgage-backed securities with maturities of one year or more. Index returns provided by Interactive Data. The returns of the indices do not reflect any fees or expenses. Returns provided are calculated monthly using a blended allocation.

1Shows the percentage of U.S. active equity mutual funds (green line) and fund assets (tan line) outperforming the total return of S&P 500 based on trailing five-year performance after fees. Funds are those in existence for five years or more and belong to U.S. growth, growth and income, and income funds (based on CRSP fund objective code). For percentage of fund outperformance, only funds with more than $10 million total net assets are considered. Percentage of fund assets outperformance is calculated as the ratio of total net assets of active equity funds outperforming S&P 500 over total net assets of all the active equity funds. Period of analysis is from January 1970 through December 2016.

2Shows median excess return of U.S. active equity funds relative to S&P 500 overlaid with the 10-year U.S. treasury yield from 1962 through 2016. Funds belong to U.S. growth, growth and income, and income funds (CRSP fund objective code). Only funds with more than $10 million total net assets are considered.


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