2. Factor investing: We have discussed various aspects of this, from smart beta to the traditional Fama-French models (listen to my interview with Rob Arnott of Research Affiliates for a detailed explanation). The academic literature on the topic of market performance implies a series of selection factors that drive portfolio returns. Investors can purchase systemized versions of fundamental-based indexes, or as Cliff Asness of AQR Capital Management LLC has noted, factor-driven strategies. These tend to do as well or better than traditional stock picking, and typically at a lower cost. It is not quite indexing, but not quite traditional active management either.
3. High active share portfolios: If you want your portfolios to beat the market, then they should not look like the market. Many people have argued this point, but none more eloquently than the legendary Bill Miller. His run of 15 straight years of beating the Standard & Poor's 500 Index is one of the most famous investing streaks of all time. Miller argues that investors have figured out that 70 percent of all active managers are “benchmark huggers” -- meaning they mimic the indexes while charging higher fees. Investors should either move to pure passive, or if they want an active manager, find someone with a high active share.
4. Niche alpha: The markets are filled with lots of inefficiencies that can be mined for alpha by insightful managers. The challenge is that these areas are not all that scalable. In other words, once the inefficiency is identified, it tends to disappear. Microcap stocks are the classic example of this, but there are many other areas where managers find success.
5. ESG: Despite all of the media attention on environmental-, social- and governance-based investing, this area is still a modest portion of total assets under management. However, there are two data-points that imply this may change during the next few decades. The first is the $31 trillion generational wealth transfer that is likely to occur during the next 20 years as the baby boomers retire, and shuffle off this mortal coil. They are likely to leave their money to their spouses and children. Not coincidentally, the biggest supporters of ESG investing tend to be women and millennials. There is a not-insignificant overlap between these two groups.
My Bloomberg Opinion colleague Justin Fox notes there is an economic role for finance beyond pursuing alpha, or market-beating performance. He quotes Burton Malkiel, author of the classic "A Random Walk Down Wall Street," who notes: “There are lots of services that can be provided that aren’t stock-picking.”
I agree with Fox that the traditional pursuit of alpha has been under assault by low-cost indexers. Indeed, my personal portfolios, just like those of my clients, are mostly invested in inexpensive indexes from Vanguard Group Inc., BlackRock, Dimensional Fund Advisors and Wisdom Tree Investments Inc. However, I am less certain that active managers will not be able to adapt to changing circumstances.
They just might control a little smaller portion of the total assets invested around the world.
This column was provided by Bloomberg News.