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Alpha Is Hard to Produce, Not Hard to Find

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While I am the founder and chief executive of a firm that specializes in actively managed ETFs, I rarely become involved in an active versus passive debate. Although generally speaking, both alpha and beta can coexist nicely within an investment portfolio, rather more often than not, that focus tends to center on the structural debate of a mutual fund versus an ETF.

While not perfect, ETFs carry far more advantages than disadvantages, and whether an advisor is seeking beta or alpha, an ETF has been shown to be a better delivery vehicle. However, ETFs still represent an important area for the active versus passive debate. One apt approach simply summarizes such consideration: Alpha is hard to produce, but not hard to find. For advisors evaluating the factors that most differentiate beta and alpha, they may ultimately view it as one side places a bet on an asset class and another group places a bet on a portfolio manager.

Every year, when different research firms release findings that indicate a substantial number of active portfolio managers are underperforming benchmark indexes, some individuals use such reasoning to demonstrate why that underperformance, coupled with managers’ fees, makes the search for active managers useless. Another viewpoint illustrates the difficulty of active portfolio management, especially over the long-term, which in turn helps measure the worth of investing with the best managers.

The great aspect of evaluating portfolio managers is that locating the best performers remains an easy task. Thanks to firms such as Morningstar, a simple search can display which active managers have outperformed the S&P 500 and other notable benchmark indexes. Through the end of May 2016, 132 active funds outperformed the S&P 500 over the last 20 years — and that was only in Morningstar’s Large-Cap Equity category. Finding top-performing managers is not a difficult undertaking.

Over that aforementioned 20-year timeframe, let’s take two active mutual fund examples. The smaller fund, the Matthew 25 Fund (MXXVX), is managed by Mark Mulholland. The larger offering, the Fidelity Contrafund (FCNTX), is managed by Will Danoff, who has notably steered the fund to significant outperformance over the last 20 years. Keep in mind, there are fee differences between the two funds, along with the substantial size differences that exist between the two firms. Contrary to how some may portray fees, the smaller fund carries a larger expense ratio than the much larger Fidelity fund. All the while, the Matthew 25 Fund has outperformed over the last 20 years. Low fees do not ensure great performance; however, great performance (as well as good marketing and sales) will drive asset growth and can allow a fund sponsor to lower fees.

Every year, a combination of pundits will remind the investing public that it’s hard to outperform and deliver alpha. It’s also hard to be a Super Bowl winning quarterback, or hit a home run in the World Series, or have your band play at Madison Square Garden. The exceptional managers stand out among a far greater number of peers. Hard work drives innovation and great performances. As fund proliferation evolves, numerous service providers can help advisors identify the right talent in the investment management space worthy of adding to their client portfolios. The good news is as that industry evolution continues, so does the availability of attractive ETF investment solutions, including alpha-seeking active portfolio managers who can be accessed in the more efficient ETF structure.

— Read more from Noah Hammon on active ETFs in “The Next Evolution of Active ETFs: Mutual Funds.” 


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