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Does active management pay off?

16. June 2015

In Sweden and Norway, for example, fund investors are complaining that they have been paying for services they have not received. This has also been picked up by the international finance press.

Fund investors believe that despite paying for active management – whereby the fund manager aims to outperform a certain benchmark index over time – they have instead been paying for units in funds structured in essentially the same way as the index, which are by definition incapable of outperforming the market. Since active management is more expensive than index management, they believe that they have been overcharged.

Actively managed funds have a high active share

Active management does not mean that managers buy and sell their holdings frequently. What it does mean is that managers conduct their own analysis, as opposed to passive index managers who base their fund selection on a given template, namely that the fund portfolio should reflect the stock market index.

How, then, can fund investors find out whether a specific fund is actively managed? One way is to look at the fund's active share. Active share is an indication of the extent to which a fund's holdings overlap with its benchmark index. If the fund's portfolio is identical to that of its index, the active share is 0. If no holdings in a fund are included in the index, the active share is deemed to be 100. A fund with low active share will in reality invest in a way that roughly reflects the market in general. This means that it will most likely be nigh on impossible to beat the market over time.

Truly active management may pay off

The question many people are asking is whether it is worth investing in actively managed equity funds or whether they are better off investing in cheaper index funds. Although this debate has been raging for some time, the arguments remain unbalanced. Active management is often directly compared with passive management.

Studies conducted by the fund research company, Morningstar, show that it does indeed matter how actively a fund is managed, as measured by active share. The higher the active share, the higher the return. Global equity funds with an active share in excess of 90 percent, for example, have delivered excess returns of more than 1 percentage point relative to the benchmark index, after fees, in the period under review.

How active are SKAGEN's funds?

SKAGEN's equity funds are marketed as actively managed funds. They all have an active share in excess of 90 percent (not including SKAGEN Focus which was launched on 26 May 2015). SKAGEN Kon-Tiki has the highest active share of 96 percent while SKAGEN m2 has the lowest, at 91 percent. SKAGEN Global and SKAGEN Vekst each have an active share of 94 percent (as of April 2015).

Over time, active management has generated a healthy profit for SKAGEN's clients. Three out of four of the equity funds have outperformed their benchmark indices by a good margin since start (see diagram 2 below). The three funds have outperformed their respective benchmarks by between 4 and 11 percentage points after fees. The funds have nevertheless not outperformed their benchmark indices every year.

Active management means that the fund will not follow the performance of the index; it may from time to time either outperform or fall behind the index. Active management in general has faced challenges in recent years, something that has affected both SKAGEN and other fund managers. In the US, for example, only 10 percent of active managers achieved returns on a par with the index in 2014 according to Denys Glushkov at Wharton Research Data Service – the lowest figure ever since the database was established in 1989. One of the reasons why active managers have struggled has been the correlation between returns. Many stocks have increased in value while fluctuations have been low, and this has had an adverse effect on active managers.

Large companies have become more expensive

The current low interest rate climate has attracted an increasing number of investors to the stock market. These have primarily invested in the most popular companies that hold the most weight in the index. Many have invested in various types of index and ETF funds which have become very popular in recent years. This has benefited large, already popular companies while active managers such as SKAGEN, whose investment philosophy is based on investing in undervalued, under-researched and unpopular companies that have potential for upward valuation adjustment, have been disadvantaged.

In SKAGEN's 2014 Annual Report, Investment Director Ole Søberg stated that: "While the law of financial gravity might be put aside for a period of time, in the long run it cannot be denied. An investment with a higher return and a solid compounded value creation will eventually outperform the investment with a lower return."

There are signs that the tide is now turning. One such sign is that the highly rated US stock market has performed more weakly than other regions this year. There is, in other words, hope for active managers like SKAGEN.

Closet index fund managers

Many people believe that equity funds with an active share of less than 60 percent should not be considered active. These funds, which still claim to be active, are often referred to as closet index funds. Closet indexing is common in many countries.

In the study "Indexing and Active Management: International Evidence", researchers have assessed this situation in a number of countries. The study shows that closet indexers are most common in Sweden where 56 percent of Swedish funds are considered to be closet index funds. At the other end of the spectrum is the US where only 15 percent of fund managers are considered closet indexers. Between these two extremes are a number of European countries where closet indexers account for around 30 percent of fund managers.



Historical returns are no guarantee for future returns. Future returns will depend, inter alia, on market developments, the fund manager's skill, the fund's risk profile and management fees. The return may become negative as a result of negative price developments.