Outsized Returns From Passive U.S. Equity Strategies Have Led Some Investors to Put Their Hunt for Alpha on Back Burner, but the Savviest Institutions Have Kept It up Front — and Are Turning up the Heat

BOSTON, MA–(Marketwired – May 19, 2015) – For the last five years, alpha returns — outperformance compared to benchmark indexes — from U.S. equity active managers have been less significant, less important to meet portfolio objectives and, at the same time, harder to find. This is largely due to the strong performance of U.S. equities, and has led many investors to put the hunt for alpha, particularly in this market, on the back burner.

However, the savviest investors always remember that what goes up must come down. They know that going where so much money is today may not reap outsized rewards tomorrow — and they remember that, in the long run, alpha returns are worth the significant effort to get them, according to Cambridge Associates, the global investment advisor to institutions and private clients.

“In the past five years or so, it has been tough to generate alpha over U.S. equities. The U.S. public equity markets are up about 200% since March of 2009, and many investors might think that, given their success at capturing strong returns via passive investing in that timeframe, there is little reason to focus on alpha now,” says Max Senter, Managing Director and an outsourced CIO within Cambridge Associates’ outsourcing investment practice.

“But piling into these kinds of passive strategies now means that you will only obtain market returns in a more difficult, lower-valuation environment. In our view, active managers who are not benchmark-focused are key for long-term returns and sustained alpha generation,” adds Senter.

Qualities of an Investor with a Maintained Focus on Alpha

“Alpha is always important, and since overall market performance won’t always be as positive as it has been over the last five years, the most successful institutional investors are always on the lookout for opportunities to generate alpha,” says Celia Dallas, Chief Investment Strategist at Cambridge Associates.

Sophisticated investors with an eye toward alpha generation exhibit a number of hallmark characteristics, including:

• Staying sensitive to valuations. Markets fluctuate between being over- and under-valued. Sophisticated investors are attuned to these shifts and their implications for alpha generation. “Chasing past performance when valuations are getting pricey tends to be a failed strategy — when prices skyrocket, savvy investors look for markets with better value and potential for outperformance. Today, some equity markets are significantly cheaper than the U.S., and have the potential for strong returns,” Dallas points out. For example, Japanese equities returned about 10% in the first quarter of 2015, compared to returns of about 1% from U.S. equities.

• Conducting due diligence when evaluating and selecting managers. It is always appropriate for investors to evaluate and re-evaluate managers and their strategies — what is working today might not work over the long term. “However, investors shouldn’t necessarily be too quick to fire an underperforming manager. We’ve found that investors can hire and fire at the wrong time, locking in losses and losing out on potential to generate alpha in the future,” adds Senter.

• Understanding the value of active management. Alpha-focused investors can find value in active managers who don’t look like the market benchmark and whose high-conviction positions may take time to generate strong returns. “Skilled, high-conviction managers have historically generated higher returns than their peers,” says Dallas. “Of course, not every manager outperforms, so manager selection is critical for success.”

• Avoiding investor psychology pitfalls. Even savvy investors must take care to avoid common psychological stumbling blocks, such as getting caught up in herd investment behavior, or invalidating an asset class because of temporary underperformance. “It’s important to keep performance differentials in perspective,” says Dallas. “Consider hedge funds. First of all, it is counterproductive to consider them as a monolithic asset class. And second, it is critical to consider the role you expect them to play in a portfolio. A hedge fund that invests globally and takes half the equity risk of global equities should not be expected to outperform the US market, even with a generous helping of alpha. In fact, this is a time when the environment could become much more attractive for active managers with a concerted focus on hedging strategies.”

• Remembering lessons from past markets. Markets work in cycles, and while past ups and downs can’t predict the future, they can provide clues for investors. “In many ways, the present moment is reminiscent of the late 1990s, when U.S. equities outperformed just about everything else and active managers found themselves in a difficult environment. That period of relative underperformance actually set active managers up for great success in the period that followed,” says Senter.

For more information or to speak with Max Senter or Celia Dallas, please contact Frank Lentini, Sommerfield Communications at +1 (212) 255-8386 / [email protected].

This release is provided for informational purposes only and is not intended to be investment advice. Any references to specific investments are for illustrative purposes only. The information herein does not constitute a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual clients. This release is not an offer to sell or the solicitation of an offer to buy any security in any jurisdiction. Past performance is not a guarantee of future returns.

Copyright © Cambridge Associates LLC 2015. All rights reserved.

About Cambridge Associates

Founded in 1973, Cambridge Associates is a provider of independent investment advice and research to institutional investors and private clients worldwide. Today the firm serves over 1,000 global investors and delivers a range of services, including investment advisory, outsourced investment solutions, research and tools (Research Navigator and Benchmark Calculator), and performance monitoring, across asset classes. Cambridge Associates has more than 1,100 employees serving its client base globally and maintains offices in Arlington, VA; Boston; Dallas; Menlo Park, CA; London; Singapore; Sydney; and Beijing. Cambridge Associates consists of five global investment consulting affiliates that are all under common ownership and control. For more information about Cambridge Associates, please visit www.cambridgeassociates.com.