From active investing to factor investing The rise of systematic management The active share debate The performance debate The Active Versus Passive Management Debate Challenge, Risk & Future Thierry Roncalli ⋆ † ⋆ Amundi Asset Management 1 , France June 21 th , 2018 1 The views and opinions expressed in this presentation are those of the author and are not meant to represent the opinions or official positions of Amundi Asset Management or any other institutions. The active share section is a joint work with Essam N’zoulou and Marielle de Jong. I would like to thank Alexandre Drabowicz, Charles-Albert Lehalle, Bruno Taillardat, the Scientific Council of AMF, and the Board of the AMF for their helpful comments and valuable input. Thierry Roncalli The Active Versus Passive Management Debate 1 / 64
From active investing to factor investing The rise of systematic management The active share debate The performance debate Foreword This presentation is not about the performance difference between active management and passive management a . This presentation does not promote active or passive management. This presentation does not take the viewpoint of investors or asset managers. This presentation takes the viewpoint of policy and regulation. This presentation is about the added-value of active management when we consider the efficiency of financial markets b . This presentation is about the stability of financial markets. The main question is: What is the minimum proportion of active management in order to ensure that financial markets will continue to work properly? Another important question is: What is the future of alpha and does this alpha will tend to be zero? a I think that this debate had been definitively closed. b that is the capital allocation between corporate firms or investment projects. Thierry Roncalli The Active Versus Passive Management Debate 2 / 64
From active investing to factor investing The rise of systematic management The active share debate The performance debate Foreword Active management could rise from the dead (Forbes, October 2016) The end of active investing? (Financial Times, January 2017) Active management isn’t dead, it’s evolving (ETF.com, January 2017) The end of an active-investing era (Barron’s, February 2017) Is there a future for active management? (Greenwich Associates, February 2017) Jack (John) Bogle killed active managers. Now he has a plan to save them (CNBC, May 2017). The death of active management has been greatly exaggerated (Morningstar, June 2017) Active management is not in a death spiral (Financial Times, September 2017) GPIF shifts to performance-based fee model for active managers (Asia Asset Management, June 2018) The long read: Is it the end of the road for active management? (Funds Europe, June 2018) Thierry Roncalli The Active Versus Passive Management Debate 3 / 64
From active investing to factor investing The rise of systematic management The active share debate The performance debate Foreword “The question is when is active management good? The answer is never” Eugene Fama, Morningstar ETF conference, September 2014 “So people say, ‘I’m not going to try to beat the market. The market is all-knowing.’ But how in the world can the market be all-knowing, if nobody is trying – well, not as many people – are trying to beat it?” Robert Shiller, CNBC, November 2017 Thierry Roncalli The Active Versus Passive Management Debate 4 / 64
From active investing to factor investing The rise of systematic management The active share debate The performance debate Key messages The boundaries of active management have considerably evolved during the past years ⇒ its scope has been dramatically reduced! The debate “active vs passive management” is now a debate between active management and systematic (or rule-based) management Like the SB, there is now a shadow asset management Systematic investment management could pose a systemic risk for the financial system Active share is an interesting benchmarking measure, but it does not solve the issues of performance and closet indexing Financial markets need active management in order to exist ⇒ What is the minimum acceptable part of active management? The debate of the performance (and benchmarking) of active management is a spurious issue and an endogenous puzzle Thierry Roncalli The Active Versus Passive Management Debate 5 / 64
From active investing to factor investing The case of equities The rise of systematic management The case of bonds The active share debate Extension to other asset classes The performance debate The nature of risk factors From CAPM to factor investing How to define risk factors? Risk factors are common factors that explain the cross-section variance of expected returns 1964: Market or MKT (or BETA) factor 1972: Low beta or BAB factor 1981: Size or SMB factor 1985: Value or HML factor 1991: Low volatility or VOL factor 1993: Momentum or WML factor 2000: Quality or QMJ factor Thierry Roncalli The Active Versus Passive Management Debate 6 / 64
From active investing to factor investing The case of equities The rise of systematic management The case of bonds The active share debate Extension to other asset classes The performance debate The nature of risk factors Alpha or beta? At the security level, there is a lot of idiosyncratic risk or alpha 2 : Common Idiosyncratic Risk Risk GOOGLE 47 % 53 % NETFLIX 24 % 76 % MASTERCARD 50 % 50 % NOKIA 32 % 68 % TOTAL 89 % 11 % AIRBUS 56 % 44 % Carhart’s model with 4 factors, 2010-2014 Source: Roncalli (2017) 2 The linear regression is: n F β j ∑ R i = α i + i F j + ε i j = 1 In our case, we measure the alpha as 1 − R 2 i where: i = 1 − σ 2 ( ε i ) R 2 σ 2 ( R i ) Thierry Roncalli The Active Versus Passive Management Debate 7 / 64
From active investing to factor investing The case of equities The rise of systematic management The case of bonds The active share debate Extension to other asset classes The performance debate The nature of risk factors The concept of alpha Jensen (1968) – How to measure the performance of active fund managers? R F t = α + β R MKT + ε t t Fund Return Rank Beta Alpha Rank A 12 % Best 1 . 0 − 2 % Worst B 11 % Worst 0 . 5 4 % Best Market return = 14 % ⇒ ¯ α = − fees It is the beginning of passive management: John McQuown (Wells Fargo Bank, 1971) Rex Sinquefield (American National Bank, 1973) Thierry Roncalli The Active Versus Passive Management Debate 8 / 64
From active investing to factor investing The case of equities The rise of systematic management The case of bonds The active share debate Extension to other asset classes The performance debate The nature of risk factors Active management and performance persistence Hendricks et al. (1993) – Hot Hands in Mutual Funds α Jensen , α Jensen � � > 0 cov t t − 1 where: α Jensen = R F t − β MKT R MKT t t ⇒ The persistence of the performance of active management is due to the persistence of the alpha Thierry Roncalli The Active Versus Passive Management Debate 9 / 64
From active investing to factor investing The case of equities The rise of systematic management The case of bonds The active share debate Extension to other asset classes The performance debate The nature of risk factors Risk factors and active management Grinblatt et al. (1995) – Momentum investors versus Value investors “ 77% of mutual funds are momentum investors ” Carhart (1997): � cov α Jensen , α Jensen � � > 0 t t − 1 � α Carhart , α Carhart � = 0 cov t t − 1 where: = R F α Carhart t − β MKT R MKT − β SMB R SMB − β HML R HML − β WML R WML t t t t t ⇒ The (short-term) persistence of the performance of active management is due to the (short-term) persistence of the performance of risk factors Thierry Roncalli The Active Versus Passive Management Debate 10 / 64
From active investing to factor investing The case of equities The rise of systematic management The case of bonds The active share debate Extension to other asset classes The performance debate The nature of risk factors Diversification and alpha David Swensen’s rule for effective stock picking Concentrated portfolio ⇒ No more than 20 bets? “ If you can identify six wonderful Figure: Carhart’s alpha decreases with the number businesses, that is all the of holding assets diversification you need. And you will make a lot of money. And I can guarantee that going into the seventh one instead of putting more money into your first one is going to be terrible mistake. Very few people have gotten rich on their seventh best idea. ” (Warren Buffett, University of Florida, 1998). US equity markets, 2000-2014 Source: Roncalli (2017) Thierry Roncalli The Active Versus Passive Management Debate 11 / 64
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