The active vs. passive management debate is heating up again. Like death and taxes, this philosophic clash of the titans may be inevitable, especially during times like these, when the bull starts running after a nice, long nap.
As an asset manager, you know the academic arguments for—and against—active management. But your clients aren’t apt to be interested in hearing what Bill Sharpe has to say on the matter. What they do want is a convincing demonstration that your particular brand of active management will add value to their portfolio.
You don’t need to load up on a new crop of fancy infographics to make your case—in fact, doing so might be counterproductive. A subtle, ongoing campaign of constant reinforcement is much more likely to remind clients why they fell in love with you—and, by extension, an active approach to asset management—in the first place. Fortunately, you can leverage your existing client communication tools —client meeting books and even quarterly reports—to deliver that message. Here are some ways you can tweak your messaging to support the case for your active investment approach.
Harness the power of the Ps
Successful active managers share certain characteristics that help them stand out from the crowd. And they tend to be very persistent about articulating them because they want to be sure their clients never forget why their approach is likely to be successful in the future. They include:
- A clear point of view about investing.
- A consistent, repeatable process.
- Use of proprietary information.
- Portfolios designed to take full advantage of manager’s skill.
- Performance metrics that align with manager’s core strengths and client goals.
These may sound like the familiar “Ps”—philosophy, process and performance—that all active managers talk about, but the most successful codify them into a belief system so compelling that it transforms clients into loyal advocates for their investment approach. From the first sales meeting to the last quarterly review, whether they are talking to the CIO or an operations specialist, these managers’ clients hear the “Ps” repeated over and over again, with a conviction and consistency that would be comical if it weren’t so effective.
If you’re already reiterating your firm’s “Ps” in every client report and presentation, then you’re on the right track. You can further harness the “power of the Ps” to bolster your clients’ support of your active approach by considering the following:
1. Your statement of philosophy should reflect what you believe about investing, not how you invest.
As a successful active manager, your greatest asset is your unique perspective on the markets. That’s what makes you different from all the other managers out there. Think of it as your investment DNA; it’s what makes you, you. So it pays to be sure you’re clearly articulating that value.
More than anything else, a well-crafted philosophy statement tells your client exactly what you believe and what they can expect from you. Think of it as your North Star. Unless something goes terribly wrong with reality as we know it, it should never change. George Soros lets us know exactly what he believes with this statement:
“Markets are constantly in a state of uncertainty and flux, and money is made by discounting the obvious and betting on the unexpected.”
Finally, don’t make the common mistake of confusing philosophy with process. Philosophy is all about belief. Process is about implementation.
2. Describe your process in a way that demonstrates consistency.
Your investment process is how you implement your philosophy. Think of it as the way you put your beliefs into practice. To get an idea of the difference, compare George Soros’ process overview statement, below, to his earlier philosophy statement:
“We try to catch new trends early and in later stages we try to catch trend reversals.”
While belief is immutable, you have choices when it comes to investment processes. Before delving too far into the weeds, it helps to give your clients a conceptual overview of the key components of your process. A high-level graphic can illuminate the two things your clients really care about when it comes to process: transparency and repeatability. Clearly identify the steps in your process and, although it may seem obvious, be sure to demonstrate that you apply these steps consistently over time. If a client doubts your commitment to your process, they’ll also doubt your ability to produce consistent results over time.
3. Highlighting proprietary information separates you from the pack.
Whether your approach is fundamental, quantitative or a bit of both, show your clients how your firm’s unique insights add value over the index. Your research contributions are what separate you from passive managers. While index funds are inherently backward-looking, active management strives to look ahead. Showcase your powerful edge over market consensus by identifying areas of opportunity others might have missed. Give specific examples of how your research is shaped by your philosophy and fits into your process. Use statistics like tracking error to explain how and why you deviate from industry/sector/style/position-size norms.
4. Show how the client’s portfolio reflects your best ideas and your strongest convictions.
As an active manager, you are expected to deviate from the market in order to achieve above-market returns. Show your client how your portfolio construction process takes advantage of your active insights to add value. If you take highly concentrated positions, let the client see how that has generated absolute returns over time. Concepts like “active share” can facilitate your clients understanding of the value you’re adding by not being a closet indexer. The portfolio construction process is a great place to talk about risk control, another key differentiator for active managers. If you have industry, sector, style or quality limits, let your clients know what they are and why you have them. Clients should understand when you will buy and when you will sell, and you should be able to quantify the contribution these decisions make to the portfolio.
Finally, if they are using a benchmark to assess performance, be clear about the extent to which you will or will not allow that to dilute potential returns.
5. Articulate clear performance metrics that align with the client’s goals.
Active managers need to be very clear about setting clients’ performance expectations on a risk and a return basis. Performance periods are particularly important—the longer the better. Every quarterly report offers an excellent opportunity to demonstrate why rolling 5- and 10-year periods are more appropriate time scales for evaluating your active approach than the last 3 months. Risk, too, should be part of the discussion. You don’t need to delve into a JPM-esque examination of relative vs. absolute risk for your clients to understand that your goal is to deliver consistent, above-average long-term absolute returns, adjusted for risk, and to not lose money in the process. That, in most cases, is the client’s goal as well. When you frame the discussion in these terms, beating a benchmark becomes incidental.
The active vs. passive management battle will probably rage on for decades. But once you harness the power of the “Ps” in your regular communications with clients and consultants, you can be sure your firm will live to fight another day.