Financial research and benchmarking provider CEM
Benchmarking says its most recent report contains enough data to prove active
investing is worthwhile for pension funds, if executed efficiently and effectively.
As noted in the report, “Value Added by Large Institutional
Investors Between 1992‐2013,” it is a widely held academic and investment industry
belief that active investors have, on average, no real advantage over passive
investors over the long term, and can even see worse performance over time due
to higher fees. This view on investing strategy is rooted in the efficient market hypothesis,
Historically, a problem with testing the benefits of active
versus passive investing is that the separation between alpha (market
outperformance) and beta (market-attributable returns) is not always clear. “Where one set of benchmarks demonstrates a
non‐zero alpha, another set can almost always be found that shows that the
alpha is zero,” the report suggests.
But while some say the question of active versus passive cannot
be definitively answered, CEM Benchmarking believes the answer can be made
clear by looking at enough information. To that end, the firm conducted extensive analysis on its pension performance data set, composed of more than 6,600 data points drawn from
a global set of defined benefit (DB) pension plans—along with a handful of
sovereign wealth funds—spanning the 1992 to 2013 time frame
“Not only can we definitively answer the question of whether
it is possible [to outperform with active management], we can also quantify to a large degree how these institutional
investors do it,” CEM notes. “What advantages do they have? Where have they
added value? Is the value added really alpha, or is it beta in disguise?”
The results are striking: Gross of investment management
expenses, CEM says, pension funds have secured 58 basis points (bps) of value added
returns through alpha-seeking opportunities. Net of investment management fees and expenses, the outperformance is much more muted, at 16 basis points of returns added.
According to researchers, a deep regression analysis indicates that beating the
market is rooted in active asset management paired with cost savings gained
through scale and managing assets in‐house.
The result is nuanced further in the CEM report: “We
emphasize that the standard deviation of the gross and net value-added populations, at about 267 and 265 basis points, are large in comparison with the averages at 58
and 16 basis points gross and net, respectively. For any single pension fund,
this result is likely just as important as the non‐zero average. The standard
deviation indicates the range that a typical plan, with a typical active versus
passive management ratio of 4:1, can expect its value added to stray from the
average. So, while the long-term average gross and net value added are
decidedly non‐zero, in any given year many funds will trail their benchmarks,
often by substantial margins.”
Report authors continue by observing that, clearly, funds
engaging in active management need to consider whether the potential gains are
worth the risk quantified by the standard deviation.