Asset class seen as key in active/passive choice

Asset class is the key basis for deciding among active versus passive management strategies for mutual funds.

That’s the conclusion reached in a study conducted by FundQuest Inc., a Boston-based wealth management advisory firm, to follow up its own earlier research. The results are slated for release on Wednesday.

The researchers looked at more than 16,000 actively managed mutual funds in 58 Morningstar categories, representing more than $7 trillion in assets. FundQuest was updating its own 2006 study by including performance and asset allocation data over the 3-, 5-, 10- and 15-year periods ended March 31.

The average actively managed mutual fund beat benchmarks in 15 of those categories, compared with 31 categories last year. Active funds performed in line with 31 categories and underperformed in 12.

The combination of additional historical data and raised standards for active managers resulted in fewer recommendations for active management.

For example, active managers in the large-growth and long-term bond categories outperformed in the 2006 analysis but underperformed in this study, moving FundQuest to a passive or index recommendation.

Other active managers in the large-value and short-government-bond categories underperformed last year and performed in line with benchmarks this year, moving them to a neutral recommendation, as neither strategy was a standout.

“Each year, a few of the recommendations will change. This year, the most notable was the shift in recommendation for the large-cap growth from an active recommendation to a passive one,” said Timothy Clift, chief investment officer at FundQuest.

With the expanded history, the results are not as specific to more recent performance, he said, “although some people would contend that more asset classes become more efficient over time.”

The study was designed to be a reference for portfolio construction.

Some industry observers are skeptical about studies that claim to predict outcomes. Geoff Bobroff, an East Greenwich, R.I.-based mutual fund consultant, points to the adage that past performance is not an indicator of future results in the stock market.

“There is nothing that I am aware of today that is a predictive tool, that you can strap onto data that says, "These are the guys and gals who are going to do well, and these are the guys and gals who are going to do poorly,’” he said. “None of them can tell you what’s going to happen tomorrow.”

Nobody can predict the future, but that doesn’t mean history is not a good teacher, said Jane Li, senior analyst at FundQuest and the study’s primary author.

“If you see the pattern over a long time, you can use the information as a reasonable starting point. We believe that past performance tells a story that demonstrates whether active management has a better chance to add value. It provides a certain level of confidence around a reasonable expectation,” Ms. Li said. The research measured the value added by active managers not just for their performance but also by their level of consistency.

The study considers asset-weighted versus non-asset-weighted calculations. Researchers examined real and traditional alpha, as well as exotic beta, which takes into account those factors outside the control of the manager and not correlated to the indexes — such as currency changes and political changes.

“Exotic beta is the difference between real and traditional beta. It helps you decide whether you want to underweight or overweight a category,” Mr. Clift explained.

In addition, researchers calculated the average performance of active managers in each category, and how many and what percentage of managers outperformed in each time period.

Other industry observers noted that the study could be helpful to advisers. The results may aid those in the institutional setting, said Burt Greenwald, a Philadelphia-based mutual fund consultant. “But for an individual investor, most are willing to settle for less in returns if the trade-off is more-consistent results.”

FundQuest plans to update the study annually.

With $36 billion under management, the company provides technology and open-architecture in-vestments to some 110 financial institutions and their advisers. FundQuest two years ago launched portfolio programs that blend equally passive and active strategies, and has provided them to a number of institutions.

Sue Asci can be reached at [email protected].