“The reason so many people never get anywhere in life is because, when opportunity
knocks, they are out looking for four-leaf clovers.” – Walter Chrysler, industrialist, founder
of Chrysler Corporation.

By Tousif Shaian Hafiz

What are the odds of finding a four-leaf clover? Approximately 1 in 10,000. Yet in the world of fund management, many fund managers build their name on being able to find a four-leaf clover more regularly than others. Building a portfolio predicated on balancing non- or low-performing stocks through a four-leaf clover pick doesn’t necessarily seem like a good idea, does it? Yet, based on historical data most actively managed funds seem to be based on finding that one clover and charging a premium for it despite rarely performing better than had their client opted for a passive portfolio built on the clover field.

Why then do actively managed funds continue to persist, and why does the market seem to love them? Actively managed funds are projected to reach $87.6 trillion AUM by 2025 (60 per cent of total market share), and fund managers will continue to make high fees on trading on these products. Surely there must be something there? There is, assuming you can find the right ones which is like finding a four-leaf clover. Approximately 1 in 5 actively managed funds will beat the benchmark passive each year, and even less will continue to do so over the following years. Why does this problem persist?

One of the core issues is conviction – fund managers and analysts, like all humans, have a bias towards a certain investment direction or thesis by which they ply their trade. This is not necessarily a bad thing, being able to draw assumptions where markets are wholly irrational can allow for abnormal returns, and activist investors drawing on normative assumptions can allow investors to put their money to good use in a profitable manner. The other side of the coin is that even the most skilled investors are rarely able to correctly identify the best way of investing in the market each year, demonstrated again by the fact that 80% of actively managed funds failing to beat the passive options in any given year.

However, for the average person investing in an actively managed fund, or an advisor looking to provide good advice to their client, or small fund outfit looking to bring their clients as much value for their dollars as they can, navigating their assumptions in a giant clover field is a Sisyphean task. There are simply too many data points for even the smartest human calculators to make robust conclusions about the true nature of the market, and the outfits that will best perform will be relying the least on intuition and most on bespoke algorithmic trading models that are hidden behind lock and key.

This highlights the other core issue involving actively managed funds. As we’ve noted a few times already, there is simply too many different clovers, or stocks and products, on the market to be able to readily grapple with on a human scale. The top funds often utilize complex algorithmic trading tools in order to develop a robust trading performance year on year – firms such as BridgeWater, Medallion, and RenTech are able to consistently beat the market using bespoke quantitative tools. Why is this the case? The long and short story is that any given investment universe is a function of millions, if not billions, of different data points and market actors (such as a fund manager) need to be able to respond to them in short form to get ahead of the market. That is not something people can properly do on their own, and employing machines and algorithmic models is the most comprehensive way to work legibly through the sheer volume of data. Smaller funds are rarely able to afford these sorts of tools and the other way to work through the sheer data amounts is to use over-the-counter tools such as Bloomberg or Refinitiv to process and assess data and work the models through in-house techniques.

What FUNDSaiQ brings to the table is a way to cut through the clutter of data, finding on the funds that can identify the four-leaf clovers within their given investment universe. That is to say, the top 2-3% of actively managed funds in each investment universe can be quickly identified against the best passives. This removes the issue of bias and conviction and allows advisors and analysts to determine what investments are best suited to their strategies and clients in a way that is faster, cheaper, and smarter than the conventional approaches.

Reference list

Cohen, T. (n.d.). Finding Superior Active Equity Managers: A Simple Approach for Investors. [online] Available at: https://www.fidelity.com/bin-public/060_www_fidelity_com/documents/Superior_Active_Equity_Managers_transcript.pdf [Accessed 4 Oct. 2023].

Hunt, D. (2022). A New Take on the Active vs. Passive Investing Debate. [online] Morgan Stanley. Available at: https://www.morganstanley.com/articles/active-vs-passive-investing#:~:text=Because%20active%20investing%20is%20generally.

Sentiment, M. (n.d.). Do actively managed mutual funds beat the index? [online] www.marketsentiment.co. Available at: https://www.marketsentiment.co/p/active-vs-passive [Accessed 4 Oct. 2023].