Winning at Active Management: The Essential Roles of Culture, Philosophy, and Technology

William W. Priest, Steven D. Bleiberg, and Michael A. Welhoelter are, respectively, CEO and managing directors of Epoch Investment Partners. It’s important to note this up front because their book,Winning at Active Management: The Essential Roles of Culture, Philosophy, and Technology (Wiley, 2016), is in part a paean to their firm. Understandably, they believe that Epoch exemplifies the best practices of active management.
The first task of the authors is to make the case for active management in the face of the industry’s pretty grim performance numbers. Even before fees, a minority of U.S. large-cap core equity managers managed to outperform the S&P 500 over one year (42%), three years (48%), and five years (46%). Only over a ten-year time horizon did a majority outperform (69%).

The authors’ argument is that the real-life insights of behavioral economists have effectively defeated what “started off as an ironclad theoretical case for passive management.” (p. 85) Even so, the strongest conclusion this argument can reach is that successful active management is possible.

Several factors work against active managers. Periods of higher correlation and lower dispersion are challenging for managers, as are times when the stocks of lower-quality companies outperform those of higher-quality companies. Active funds also experience a drag from cash holdings. And, of course, they fall victim to the paradox of skill. As Mauboussin described this paradox, as participants in an endeavor become more skillful as a whole, luck becomes an increasingly important component of any one participant’s results.

Theoretically, active managers can outperform stock market averages because behavioral biases create market inefficiencies. Practically, “most managers have not been following an approach that is likely to work.” The authors contend that “capturing the impact of stock-specific inefficiencies requires a disciplined process that (1) understands the forces that create an inefficiency, (2) captures it by ‘casting a wide net’ across stocks that are likely to be affected, and (3) properly structures the portfolio so as to filter out the impact of any factors (e.g., size or industry effects) for which the manager currently has no forecast, and which might otherwise swamp the excess return generated by the inefficiency that the manager is trying to capture.” (p. 106)

Michael Mauboussin: Here’s what active managers can do

michael mauboussin, Credit Suisse, valuation and portfolio positioning, capital markets theory, competitive strategy analysis, decision making, skill versus luck, value investing, Legg Mason, The Success Equation, Think Twice: Harnessing the Power of Counterintuition, analysts, behavioral finance, More Than You Know: Finding Financial Wisdom in Unconventional Places, academics , valuewalkThe debate over active versus passive management continues as trends show the ongoing shift from active into passive funds. Q2 2020 hedge fund letters, conferences and more At the Morningstar Investment Conference, Michael Mauboussin of Counterpoint Global argued that the rise of index funds has made it more difficult to be an active manager. Drawing Read More


The investment philosophy of the authors’ firm is that “cash flow is the origin of value in stocks, and that forecasts of cash flows should be the basis for security selection.” (p. 133)

The authors also address the role of technology in investing. Will computers eventually take over the world of investment management? The authors not unexpectedly take the position that “investing is too important for robots alone.” Instead, they are, in the words of one of their firm’s recent initiatives, “racing with the machine.”

Three appendices to the book present selected articles and white papers of Epoch Investment Partners, a review of principles of valuation for financial assets, and a case study about disclosure written by Jack Treynor in 1993.

 

Winning at Active Management: The Essential Roles of Culture, Philosophy, and Technology