A fundamental decision any investor can make is whether to choose an active or passive fund manager. The choice between active or passive reflects that person’s assumptions, either consciously or unconsciously about several things: is the market efficient? Can they confidently identify a skilled manager? And can that manager add value relative to the benchmark after fees?

If an investor believes a particular market is highly efficient, then they would expect an active manager would have no advantage over a passive manager in identifying ‘mis-priced assets’.

If, on the other hand, they believe that markets may not be fully efficient, then they will likely prefer an active manager.  However, identifying a skilled manager can be difficult.

It’s well accepted that historical returns can’t be relied on to predict future performance; however, they can certainly help to identify conditions under which active managers are likely to perform well or not. Understanding how those returns were achieved can help investors take a view on whether superior future returns can be replicated again.

So, what are some of the characteristics that superior active managers exhibit? The characteristics with the strongest empirical support* include the following:

Experience; at least among larger funds, experienced managers tend to outperform those with less experience.

Social connections; managers who have social connections with senior people at the companies they follow tend to outperform those without such connections.

Academic background; managers with high quality qualifications and credentials tend to outperform their peers and have also been shown to take lower tracking error risks while pursuing performance.

Turnover and cash levels; managers that maintain lower turnover in their portfolios and lower cash levels tend to outperform their peers.

Contrarian investment process; managers that take a differing view from undertaking superior company analysis can outperform ‘herding’ managers that tend to follow the same themes.

Stable risk profile; managers with shifting risk profiles tend to underperform managers that maintain a stable risk profile.

High ‘active’ share; managers who take bigger active positions away from the benchmark, combined with low levels of turnover (as mentioned above) tend to outperform their peers.

As long as markets are not completely efficient, and at Milford we generally believe they aren’t, and as long as there are differences in human intelligence and skill levels, some active managers will outperform through real skill, not just luck.


*CFA Institute, 2018, CIPM programme – topics in performance appraisal.