Host: Welcome back to the Truist Nonprofit Insights Podcast Series! We’re glad you could join us. Active versus passive management. It’s a familiar point of debate, especially during a long-standing bull market. On average, institutional managers have struggled to keep pace with market benchmarks in recent years. But is a passive approach really the better option? Elizabeth Cabell Jennings, director of institutional investments for Truist Bank, discussed the issue with Tracey Devine, Director of Manager Research for Truist Wealth.
Elizabeth Jennings: You know, every time these days I read the Wall Street Journal, I see an article about how the average institutional manager has underperformed their benchmark over some long time period. As investors, shouldn't we really expect better returns?
Tracey Devine: Yes, we should, and we do. I think the performance time period is what's critical here. So by design, active managers, they take a different path as we know in terms of achieving a risk return profile. They're simply managing differently than the index construction methodology.
The asset selection from an active manager is much more focused. It doesn't change as the markets start to emphasize one segment over the other. The strategies are expected to go through periods of relative underperformance.
There are many managers that have successfully delivered a competitive performance and often at less risk, and the goal obviously is to invest with some of the most skilled managers in each asset class, acknowledging there's going to be market environments where we expect outperformance and when we expect underperformance. The power of patience with a skilled manager is well rewarded.
Jennings: Tracey, when I look at all the companies out in the marketplace, aren't index funds really the easiest and most efficient way to invest because you own some of everything?
Devine: Easy and efficient stood out in that question. Really good question. Indexing definitely offers the lowest fees for the market exposure, and that's productive. That is definitely its leading and most compelling trait. There's definitely merit in considering indexing as one of the easiest ways to invest, given the convenient fund structures, no relative return considerations, and historically, fewer options to select from.
Indexing can absolutely be a productive investment when the investor clearly understands the risk/return expectations and tradeoffs and they have the discipline to avoid selling during the extreme down draft.
Yet in an efficiency sense, with risk representing the expense, an investor's trying to maximize returns for a given level of risk. To address a variety of risk-adjusted outcomes, the investor's likely going to find that variety by way of more actively managed strategies.
Jennings: Given that we may be in a modest return environment, especially in the U.S., shouldn't we just look for the lowest fee? Why wouldn't we just hire the manager with the lowest expense ratio?
Devine: Some studies actually note low fees as one of the strongest determinants for long-term active manager success. The more you keep the fee structure low, obviously the more return gets delivered to the investor or to the client. So that's a win.
On the other end of the spectrum, we've got the longstanding battle cry of active managers that the important metric is net returns, not the gross fee. In other words, there are many managers that have elevated fees, but they deliver. They outperform. So I think that our initiative is to identify a competitive fee wherever possible and acknowledge that we need to hold that manager accountable for their relative performance.
Jennings: Tracey, I understand that managers earn different returns from the benchmark and all we hear about usually is the return side. What about the risk side? How do we think about that?
Devine: My favorite question. Every single manager we talk to has a thoughtful approach—different, but thoughtful approach towards risk management relative to their universe of investments. They can't mitigate all risks, naturally, but each assesses a variety of tradeoffs when they're designing their investment process. So active managers typically will emphasize a desire to preserve capital and protect against permanent loss. How they approach it is different. Usually, we hear about things such as valuation sensitivities, the emphasis on business quality. Portfolio diversification is huge, and that just represents a few of the very common risk management tools.
Active managers often will allocate more to higher quality companies given the fundamental research they do. These businesses are not going to fall as far as a lot of the other businesses that might be held or exposed in an index fund given passive flows and strong index performance, active managers have come under great scrutiny right now.
The longer the active manager lags, the greater the pressure to look like the index. And honestly in some areas of the market within an index, you're going to see some additional risks. We don't want our managers to start to mirror that. Most of our managers proactively acknowledge that they will not succumb to taking those pressures. So the bottom line is risk matters a lot and it's the crux of our due diligence.
Host: We hope that you enjoyed today’s podcast. This podcast was brought to you by the Truist Foundations and Endowments Specialty Practice which has more than a century of experience working with not-for-profit organizations, delivering comprehensive investment advisory, administration, planned giving, trust and fiduciary services, to over 700 not-for-profit organizations.
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