Why Advisors Can’t Find Skillful Active Managers

November 4, 2014

by Michael A. Ervolini

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Cabot Research and Bloomberg LP are co-hosting “Reviving Active Management: Improving Tomorrow, Starting Now” an industry conversation about the future of active management on Tuesday, November 11, 2014 at the Bloomberg headquarters in New York. To register to attend this event contact: info@cabotresearch.com

Allocating client capital among actively managed funds is a difficult business. One approach is to follow the herd and put your clients with the other “hot money” in the market. The obvious shortcoming of this is that it is too easy to be the last one on the bus and find out that you’re once again buying high only to sell low. An alternate approach is to identify out-of-favor funds  – the so-called contrarian investing. This style is suitable only when both you and your clients have the courage to plow capital into funds that are experiencing heavy outflows. The potential downfall to contrarian investing is that the other guys may be right; you might be loading your capital on a sinking ship.

Both approaches are based on hope as much as on real insight with regard to which funds are likely to deliver strong performance going forward.

The challenges of identifying superior funds is not unique to advisors or individual investors. Institutional investors also find this process vexing if not downright impossible. Institutional investors can rely on professional in-house staffs and benefit from the advice of independent manager search consultants. Even with such ammunition these well-heeled investors often misfire.

The overwhelming disappointment in picking skillful active managers fuels, to a large extent, the common perception that above average performance is due to luck rather than skill. Because, after all, if skill were involved then advisors and institutional investors would be better at picking funds, wouldn’t they?

Wrong! The fact is that despite years of wrangling over skill versus luck, no one really knows much about skill, and that is at the heart of the problem.

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