How to win a losing game

At Morningstar’s institutional investor forum in Vienna, funds industry experts presented their views on fund selection and fund analysis, calling for a fresh approach to the active versus passive debate.

There are many ways to improve fund selection. That was the bottom line at the Morningstar Investment Conference Europe in Austria’s capital Vienna.

It was a premiere, as the fund analysis powerhouse brought its institutional investor forum to European soil for the first time. Joe Mansueto, chief executive of Morningstar, and his team set a broad agenda.

As he tells InvestmentEurope: “The size of the fund industry shows that it performs an important and successful role for investors.” Yet, according to Mansueto, it is the growth of the passive investment industry that induces massive change to the current playing field.

Morningstar’s chief executive echoes the analysis of KJ Martijn Cremers, professor of finance at Yale School of Management. The Dutch academic works on an alternative measure for active management and presented it to the 300 participants in Vienna.

With colleagues, he created the ‘active share’, a measure that represents the share of holdings within a fund portfolio that differs from the benchmark holdings.

Funds with low active share are ‘closet index funds’ and investors should keep a wary eye on them. According to Cremers’ findings, these fake active funds underperform significantly after costs, whereas truly active funds tend to outperform.

Liquidity and forecasts

Thomas Idzorek, chief investment officer and director of research at Ibbotson Associates, the financial research group acquired by Morningstar in 2006, takes this novel stance when it comes to equity research. In a talk that sparked a lot of discussion among conference participants, he pointed out the important role of liquidity as a performance predictor for equities.

For Idzorek, the indicator catches the ‘popularity’ of a stock as unpopular stocks are not traded: “All the factors, except momentum, depict some aspect of popularity.”

The consistent use of these tools is crucial to find alpha managers, those who add value by outperforming their benchmark, says Idzorek. “It is about winning a losing game,” he adds.

As alpha is zero across the market as a whole, it is negative after fees. Small investors without the research capacity thus should stick to choose attractive, passive and cheap instruments. Indeed, a good part of the conference involved ETFs.

Representatives from the biggest industry players (iShares, Lyxor ETF and db X-trackers, which have a combined market share of roughly 70%) discussed recent trends in this growth market.

As Thorsten Michalik, head of db X-trackers (Deutsche Bank’s ETF provider) points out, the growth in the industry was driven by the products’ strength and resilience in the crisis. But until now, the European market for ETFs is still concentrated with long-only, buy-and-hold mandates.

“It would be great to see the development of a short side of ETFs”, he says, as it is already developed in the US market. This would enable investors to hedge their market exposure directly via put options on the exchange-traded products.


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