guaranteed active management

Investors have been moving in droves from active to passive funds, i.e. from funds with high fees to those with low fees, from managers who promise higher than market returns to those who track some broad market index, such as the S&P 500, Russel 1000, FTSE 100 or Nikkei 225.

Critics point out that active managers, on average, perform no better than the market. After fees they perform much worse than the market, so investors are better off placing their savings with passive managers who charge lower fees. An added advantage of passive management is that the return will never be much worse than the index that the chosen fund is tracking.

FT reader Jason MacQueen has found a way to silence these critics. His solution is “guaranteed active management”. The manager places his own money in the fund, along with that of the client, and promises a return equal to the market (index) return plus, say, 0.5%. Instead of fees, the manager pockets all returns in excess of the guaranteed amount.

In short, the investor secures returns that are guaranteed to beat (by a fixed percentage) returns promised by passive funds. Moreover, all the downside risk is borne by the manager. How is this possible? Mr MacQueen explains.

To effect the guarantee, the funds are held by a reliable third party custodian, and there is a legally binding agreement which says that if the manager’s share of the fund’s assets ever falls below, say, 3 per cent of the total, the custodian simply liquidates the fund, gives the investor their funds plus their guaranteed return to that date, and remits the remainder to the manager. It has often been said that you can manage risk but you can’t manage return. In this model, the manager not only manages the risk but also bears the full consequences of not doing so, and, of course, reaps the rewards of doing so efficiently.

The investors are happy, since they are getting guaranteed outperformance with no fees. The regulators should also be happy, since they now have full transparency of the fees. The manager, presuming, of course, that they can actually generate an average outperformance of better than 0.5 per cent a year is also happy, because they are keeping the excess return.

All it requires is an active manager who actually believes they can generate reasonably consistent outperformance of their benchmark. Are there any takers?  [Emphasis added.]

Jason MacQueen, “Taking an evolutionary step to save active management“, letter to the editor, Financial Times, 4 January 2017 (metered paywall).

Mr MacQueen is Managing Director of Alpha Strategies, a US company set up in 1997 to provide advice and “innovative investment strategies that generate performance in excess of a given benchmark”. He and his company have been promoting “guaranteed active management” at least since February 2001.

So far, there have been no takers, at least none that are visible in a google search.

Why? My hypothesis is that active managers refuse to bear the risk of performing worse than the market.


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