In previews posts I have commented on the various stock indices, which can be described as well known collections of the most representative companies of a country, region, or industry. These are often used as benchmarks for different investors.
Globally, there has been a strong trend to participate in the stock market through ETFs, or indexed funds. Only from 2008 to date we have seen the growth of assets under this type of management, advancing from 710 billion dollars to 4.83 trillion dollars at the end of 2017. Where the three largest players in the United States: Blackrock, Vanguard, and State Street account for 70 percent of the global offer.
This trend has led many investors to wonder about the future of active management.
What is active management?
Contrary to an intuitive approach, where someone could think that this refers to the continuous purchase and sale of securities, this term refers to having an active exposure different from that preset by some index parameters.
Through active management, portfolio managers—or investors—could decide to increase, reduce, or eliminate exposure to one or more names in particular.
For example, the IPC contemplates stocks from 35 different Mexican companies, to have a passive exposure it would be enough to buy these 35 names in the proportion indicated by the index. On the other hand, if an asset manager sees better opportunities in companies that are not in the index, or changing the percentage with which he participates in any of the constituents, we would be talking about active management.
I will try to explain this through a more familiar example, taking advantage of the fact that the NFL season is right around the corner, hopefully.
Many lovers of the gridiron play in Fantasy Leagues, where several participants form line-ups week after week, looking for the best players available, regardless of their real life teams. Each player will generate points according to the performance they have in that week with their own teams in real life. To give us an idea, if a runner manages to accumulate 70 yards, he will add 7 points, and if he scores a touchdown, another 10 points. The participants of the leagues will see how their managerial skills will allow them to add a greater number of points each week to defeat their league rivals.
Let’s suppose that the reference index is the Dallas Cowboys team, but you consider that in the league there are better wide receivers, so I would “drift” from the reference team, looking to line up Tyreek Hill and Adam Thielen, instead of Williams and Beasley. If in addition I consider that Dak Prescott has irregular performances, with volatility in his points generated week to week, I could look for a more consistent quarterback, like Phillip Rivers.
In this example we can define that the active risk would be how much my roster differs from the one we take as a reference.
Just as in the stock market the risk can materialize in poor performance of the players, or injuries, and we must be very clear about the opportunity cost. For example, in week 6 of the NFL, Phillip Rivers generated 14 points while Dak Prescott added 29, having opted for a different name from the benchmark had a 15 points cost on our performance.