What Is Active Management?
Active Management is the process used when institutional asset managers apply their specific area of expertise by combining fundamentals, analytical research, and market forecasts to assess which securities to buy, hold and sell within the portfolio they manage. This active management approach leads to portfolios of securities that tend to be more concentrated and generally different from their respective benchmarks—this DISTINCTIVELY ACTIVE® quality is at the core of Touchstone’s actively managed mutual funds.
Why Is It Important to Consider Actively Managed Funds?
Touchstone’s focus on active management is grounded in the idea that an equity fund with high active share has the opportunity to outperform its benchmark—something that is very difficult to do if a fund’s holdings largely overlap what its benchmark holds.
What Is the Difference Between Active and Passive Management?
Active management is a hands-on approach to portfolio management, whereby a manager buys and sells securities based on fundamental research, forecasts, skilled judgment, and conviction. Truly active managers have holdings that are highly differentiated from the benchmark, seeking to outperform the market indexes over time.
With passive management, the manager holds securities that mirror a market index such as the S&P 500. The goal of passive funds, such as an exchange-traded fund (ETF), is to capture the market’s average returns over time, not beat the market. Passive management typically does not involve active trading to manage volatility or address market influences.
Touchstone believes that active management provides the differentiation required for a robust approach to portfolio construction. In our view, a diversified portfolio can contain a mix of active and passive funds and should always be aligned with the needs of the client.
What Qualities Are Important When Choosing an Active Asset Manager?
While Active Share can be a helpful measurement for investors looking for equity funds with alpha generating potential1, it is not designed to evaluate the performance or skills of individual portfolio managers who employ active management strategies. Active Share may be one consideration used in a selection process for choosing actively managed mutual funds, but Touchstone has developed a more comprehensive framework which includes five factors that we believe can help determine the quality of active management: Skill, Conviction, Opportunity, Patience, and Expenses, or SCOPE.
1Alpha is the portion of a fund’s total return that is unique to that fund and is independent of movements in the benchmark.
In addition to having expertise in their respective asset classes, Touchstone believes active managers should exhibit skill at selecting investments, maintain tenured and credentialed staff and show the consistency of results over the life of the strategy.
Furthermore, Touchstone believes they should demonstrate conviction by having confidence in the companies in which they are invested and maintaining discipline and commitment to their investment approach over time. Conviction can be measured by the total number of holdings in combination with the concentration of stocks among the top holdings. For example, a more concentrated active manager may target 30 to 40 companies rather than investing across hundreds of stocks.
According to Professor Martijn Cremers, PhD, opportunity is equal to a "relative lack of constraints—whether planned or client-enforced". Examples of these types of constraints include; position size, industry/sector exposure, capitalization, geographic region and tracking error.2 An actively managed fund with a high Active Share suggests a relative lack of constraints and thus the flexibility to implement a highly differentiated strategy.
Patience involves an active manager staying the course and buying companies rather than trading stocks. Finally, it’s important to understand expenses—the cost for active investing. This includes understanding not only the fund’s net expense but also the Active Fee which is the cost of the active portion of the portfolio; because the active portion of the portfolio is the only portion that can possibly outperform the benchmark.
2Tracking error is the difference between a portfolio's returns and its benchmark.
What Are the Benefits of Actively Managed Funds?
Touchstone believes active portfolio management offers investors important benefits as it seeks to provide differentiated returns. Active management has asset managers pick securities rather than replicate various market indexes. With an actively managed fund, the asset manager’s experience, skill, knowledge, and judgment all come into play. If an active manager has years of experience in a particular segment of the market, the manager can leverage that expertise to select specific investments in an effort to meet the fund's goal.
How Touchstone Approaches Active Management
Touchstone seeks active management strategies that we believe have the potential to provide excess returns and complement portfolios. We expect our mutual fund’s sub-advisors to demonstrate a consistent and repeatable investment process. Expectations are reconciled against actual portfolio characteristics, holdings and transactions, using various investment-specific metrics, including Active Share, to monitor consistency of process and benchmark differentiation.
Touchstone seeks to provide investors with results-oriented investment expertise from distinctive institutional asset managers to whom the company outsources the management of its mutual funds. These asset managers are selected and monitored based on a disciplined process over a broad range of criteria, including organizational stability, personnel, investment discipline, infrastructure, and performance. Together these factors form the basis of Touchstone’s proprietary analysis, a multi-factor model used to provide an overall assessment of current and prospective sub-advisors.