Why Active Management Still Matters
Summary
- Volatility, as measured by the CBOE Volatility Index, has averaged 24.73 since the onset of COVID-19, a significant jump from its 14.46 pre-pandemic three-year average.
- In this environment, we believe broad-based directional trades and style-timing strategies are becoming inherently riskier, further magnifying the importance of in-depth investment research.
- At the individual company level, we believe investors can capitalize on these opportunities by staying disciplined and focusing on companies that generate strong, reliable free cash flows.
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By Richard S. Nackenson
Passive indexing paid off in the cheap-money era, but now we think it’s time for a more thoughtful, idiosyncratic approach.
In 2022, a decade characterized by easy monetary policy and historically low interest rates came to an end. The era of free money is now over. With money no longer cheap—and volatility and style disparity on the rise—we believe thoughtful active managers can capitalize on idiosyncratic opportunities to generate alpha and manage factor-specific risk.
Volatility, as measured by the CBOE Volatility Index (VIX), has averaged 24.73 since the onset of COVID-19, a significant jump from its 14.46 pre-pandemic three-year average.1 Short-term, macro-focused trading driven by the increased prevalence of strategies such as Commodity Trading Advisors (CTA) Funds and tools such as Zero Days to Expiration (0DTE) options are amplifying market movements on a daily basis. Likewise, style disparity—which is the return difference among the best and worst performing “style box” segments—has averaged 28% over the last three calendar years, up meaningfully from an average of 16% in the previous three calendar years.2
The Active Management Opportunity
In this environment, we believe broad-based directional trades and style-timing strategies are becoming inherently riskier, further magnifying the importance of in-depth investment research. Idiosyncratic opportunities are presenting themselves to fundamental equity investors. At the individual company level, we believe investors can capitalize on these opportunities by staying disciplined and focusing on companies that generate strong, reliable free cash flows.
Also essential, in our view, is understanding the summation of specific exposures in order to control risk at the portfolio level. To that end, we believe fundamental and macro-factor-based monitoring can more clearly reveal specific risk exposures and highlight whether or not portfolios are properly constructed.
In the current higher-rate, more volatile economic regime, we believe investors are able to adapt to shifts in the market while minimizing unwanted or unknown factor exposures—objectives that skilled active managers, in our view, are best equipped to achieve.
Source: (1) CBOE Volatility Index (VIX) is a calculation designed to produce a measure of constant, 30-day expected volatility of the U.S. stock market, derived from real-time, mid-quote prices of S&P 500® Index (SPX℠) call and put options; (2) Russell indices
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