Hi mrdarcy,
Thank you so very much for alerting me to Radford University Professor Abhay Kaushik’s work. I was completely unaware of it.
Since Kaushik’s results appear to contradict others in the active-passive fund management debate, I am excited and anxious to examine his study. Unfortunately, the Link you provided does not permit access to his full report; it merely yields an abstract of his paper. I still have not seen his complete report.
However, a quick Internet search uncovered a few reviews of his effort. I dislike these secondary sources and greatly prefer the primary report which still eludes me. However, perfect knowledge is rarely accessible in the investment world, so I’ve made a temporary assessment with imperfect information. Nothing new to investors in this regard.
I basically examined two secondary sources on this matter: BAM Alliance’s Larry Swedroe and Morningstar’s John Rekenthaler. Here are the Links to their reviews:
http://www.cbsnews.com/news/dont-believe-everything-you-read-this-post-excluded/http://news.morningstar.com/articlenet/article.aspx?id=608086Notwithstanding my reservations, here are my present thoughts on Professor Kaushik’s research and how it integrates into the impressive body of earlier works.
At first glance, the referenced work might appear to be an anomaly since, on the surface, it seems to depart from a bevy of academic and industry studies. That is not necessarily so upon slightly deeper thinking.
Much depends upon the design of the experiment, its timeframe, and the selected benchmarks. Also the inclusion or not of fund survivorship bias in the study is unclear. Unfortunately, these are unknowns to me at this juncture and cloud a final quality judgment. Not all academic and industry empirical studies are of equal quality or scope.
Also, it is important to recognize the overarching conclusion of all the work in this field. There is no fundamental reason why either active or passive fund management is superior for all circumstances, An Iron Law on this matter does NOT exist. Most active/passive studies demonstrate that superior performance is achieved by a passive discipline, but it is not a universal truism. Much depends upon the meticulousness of the screening process and the timeframes considered.
When the Meketa group did its work, they concluded that passive fund management outdistanced active elements in both the Large and Small Cap equity arenas. However, when they parsed these categories into value and growth units, Meketa discovered that Small Cap Value active fund managers did generate positive Alpha. Results do depend on the fineness of the category structuring.
Additionally, study outcomes depend upon timeframe. The Meketa studies are longitudinally (time dependent) sensitive. MIG concluded that some active management categories produced positive Alpha during market meltdown years. Situational awareness is needed when interpreting all research findings.
In MIG’s world, the developed foreign markets were modeled as a single entity; apparently in Kaushik’s world, that same category was subdivided into 13 distinct groupings. Of course, each of these separate units was measured against specific benchmarks. It is not surprising that with this finer structure, some generated positive Alpha winners and some did not. The Kaushik abstract suggests total victory; the actual results tell a more complex ending.
The referenced abstract summary overstates the universality of its findings. Within its 13 sub-groups, some passive units outperformed the actively managed funds. The abstract was not sufficiently nuanced to acknowledge that detail.
How the fund survivorship bias is handled in any serious study is a major issue. Note the extreme care that the MIG team exercised when assembling their database. The first few pages of their report emphasize and document the potential impact that fund survivorship bias has on any final findings. It is not clear how Kaushik addressed this likely high impact parameter when organizing his research.
The relative gaps between active and passive fund management is a temporal thing; it is dynamic. The longitudinal charts that are an Appendix in the MIG report documents the performance gaps time-sensitive nature. As information becomes more widely accessible, apparently active management positive Alpha becomes more challenged.
The referenced work is surely controversial. Although I believe there is no Iron Law that dictates active versus passive performance outcomes, I do subscribe to the market’s regression-to-the-mean rule that seems to enforce a negative feedback loop that limits market distortions. Even the referenced work finds that, in some instances, weaker earlier fund actors outperformed their previously superior counterparties at a later time. Persistency is a hard nut in the marketplace.
I love these types of controversies. They inspire more careful research. That’s a good thing. A huge majority of the current findings fall in favor of passive fund management, but not always and not under certain circumstances. Overall. it is a conditional finding.
Before I became acquainted with this recent research, I was strongly influenced by the S&P SPIVA and persistency scorecards. They too demonstrated that a universal law simply doesn’t apply, but the odds favor the passive management approach. Exceptions exist in certain categories and under certain market conditions.
The bulk of research in this arena concludes that under most conditions, and for many investment categories, actively managed funds underperform competitive passive products. I find this assemblage of studies persuasive. I put more trust in these composite findings, especially since most of the contradictory evidence can be explained by details in the applied methodology.
As an acknowledgement to these numerous studies, I concluded that my portfolio needs an adjustment. Its present allocation is roughly a
50/
50 split between actively and passively managed funds; I plan to settle on a 20/80 mix that is heavy in less costly passive products. I appreciate and honor the fact that, under certain circumstances, the active products can earn their higher cost drag. The Kaushik study has not caused me to revise my plan.
Sorry for my incomplete and imperfect reply. I simply do not have the primary report for a more comprehensive review. Incomplete knowledge is one universal constant when investing.
I hope this is helpful. Once again, thanks for your post.
Best Wishes.
