A New World and New Opportunities for Alpha

Pandemic-driven volatility has once again highlighted the relative virtues of active and passive management.

Art by Marc Rosenthal


Generally speaking, investment managers agree that actively managed funds perform better in periods of market volatility and decline. However, they do not believe that plan sponsors that primarily offer low-cost passive funds should change their investment lineup at this time, because they believe sponsors should be committed to their long-term outlook for their plan and their participants.

Joel Schiffman, head of intermediary distribution at Schroders, North America, says, “It is fair to say that, from the studies I have read, in a rising market, passive funds tend to perform better, and in a declining market, actively managed funds tend to outperform. The higher the quality of the active manager, the more likely they will outperform the markets in a declining environment. They can sell securities to raise cash and spread around factor exposures to mitigate risk. Passively managed funds are essentially the market, and it is all market-cap weighted, and they go down accordingly.”

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Chris Herman, head of investment strategists at Fidelity Investments, notes that, in periods of high volatility, active management will outperform to a higher degree when the possibility of both outperformance and underperformance is there.

“Active management outperforms during recessions,” Herman says. “That said, it is important to examine the individual portfolio manager’s investment philosophy.”

Sona Menon, head of the North American pension practice at Cambridge Associates, agrees with that premise, saying active management comes in many forms.

“Some funds are only mildly active and are closer to a benchmark,” she observes. “Other managers take fairly large bets away from the index. They are higher tracking error managers. Some active managers we work with have done very well. It depends on their investment philosophy and if they are invested in a favored area of the market.”

Menon says winners in the past few years have been large-cap growth, quality and momentum companies.

“Active managers who lean into those industries and styles of investing have done very well,” she explains. “Value, small-caps and cyclicals have struggled.”

In terms of the current market, Menon says, active managers that used the market’s sharp drop in March to buy stocks at inexpensive prices have done well as the market has rebounded.

“Also, active managers have the ability to rotate capital and hold cash,” she adds. “In March, when the markets sold off, some managers deployed their cash and were able to participate in the April recovery. Rotating capital is one of the key things to do in volatile times.”

As to why passively managed funds do well during bull markets, Jeremy Stempien, a portfolio manager with QMA, a PGIM asset manager, says that “it is not so binary.”

“The reality is that different up and down markets and periods of time are all driven by different factors,” he explains. “But, generally speaking, looking back historically, the numbers would provide evidence that during periods of economic prosperity, passive investments have done well. The reason for that is in a normal environment. When things are going well, the markets become clearer and more transparent. Earnings are easier to forecast, information is more transparent, and markets are more efficient. It can be harder for active managers to find opportunities for alpha.”

On the flip side, Stempien continues, during periods of volatility, events and markets become much less stable and transparent.

“This creates disruptions in the markets,” he says. “In these times, active managers that are sound and reputable can substantially outperform the market.”

As for the question of whether investment committees should replace index funds with actively managed funds in the current volatile environment, Schiffman believes they “should take a long-term view” when they convene for their mid-year reviews.

“The questions they should be asking include what are they trying to achieve and what their, and their participants’, appetite for risk is,” Schiffman says. “They might want to explore their market perspective for the future and act accordingly. If they decide they want to mitigate risk, they might turn to more actively managed funds. On the other hand, other plan sponsors don’t want to pay the fees and prefer to stay passive and go where the market goes. It isn’t a uniform or straight question for sponsors. You could make different arguments for both active and passive management.”

The most important question investment committees should be asking themselves, Schiffman says, is how much risk they’re willing to take on.

“If they think that if they go to an active manager they can generate alpha net of fees, then it is more likely they will embrace active management,” he says. “This is a much more valid conversation today as opposed to last year, when we had upward movement in the market.”

Herman also says investment committees should not necessarily be making any changes to their lineup at this time.

“While some of the funds took a hit in the past three months, we would say that they should not change their investment lineups based solely on what has happened in the past three months,” Herman says. “It is a best practice for plan sponsors to evaluate funds over a longer period of time. We typically talk to plan sponsors about performance over at least one-, three- and five-year periods—and sometimes longer. Sponsors should not react to short-term market volatility, but if they were already planning to replace an underperforming fund with another, we think they should go ahead. Many of our plan sponsor clients are not reacting in a knee-jerk fashion, but some are asking for more information about the funds in their plan.”

Stempien echoes that idea. “In the defined contribution [DC] space, sponsors need to put on a different lens when it comes to the active versus passive argument,” he concludes. “Given their fiduciary responsibilities, they should be focused on a more strategic perspective for their plans and have a methodical, slow process for fund selection. While the litigious environment of the past 10 years has put added pressure on plan sponsors from a price perspective, resulting in a push to passive, they should think about the active/passive decision from the standpoint of suitability and not permit the pressure of fees to overwhelm that decision.”

Paycheck Protection Program Considerations for Advisers

Like any clients that have taken advantage of the Paycheck Protection Program (PPP), advisory practices must be careful about the provisions the Small Business Administration has set forth to make any payments forgivable.

Art by Philip Lindeman


Just like other small businesses that have been negatively impacted by the effects of the coronavirus pandemic on the markets and their profits, retirement plan advisory practices have been hit hard, and some have applied to the Small Business Administration (SBA) for grants from the Paycheck Protection Program (PPP).

Bimal Shah, chief executive officer of Rajparth Achievers, has not only helped clients apply for PPP grants, but he has obtained a $40,000 loan for his own practice. “We have been affected by the virus and needed the help,” he says.

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Julia Carlson, founder and chief executive officer of Financial Freedom Wealth Management Group, says her practice also has been affected as its fees are based on assets under management (AUM).

“With the markets dropping 35% in March, literally freefalling, it led to sheer panic not only among our staff but among our clients,” Carlson says. “When we realized our income could potentially drop by 35%, we applied for a PPP loan and obtained $211,000. I applied because I wanted to act in good faith and be a steward over my staff.”

The purpose of the loan is to keep the business solid and help remove some of the uncertainty, Carlson continues.

“The PPP loans have brought confidence to my business and the small businesses that we serve,” she says.

Like Carlson, Robert Skloff, portfolio manager with Silver Pine Capital, says his firm’s revenue is dependent on assets under management and, therefore, dependent on how the capital markets perform.

“The Dow dropped as much as 37.1% at its worst in March,” Skloff says.

At the same time, he warns other advisory practices that take out a PPP loan to be careful about the provisions the SBA has set forth to make any payment a forgivable grant, rather than a loan.

“There isn’t much information readily available,” Skloff says. That led him to create a website, www.pppforgivenessinfo.com, which includes a PPP forgiveness and optimization tool that can handle companies with up to 25 employees and is available for $59.99. If a firm uses the optimizer, the biggest portion of PPP payments, or 75%, will be directed toward payroll costs, Skloff notes.

“The importance of knowing how you are tracking against both what you included in your PPP application and the amount of your loan is essential,” he says. “The allocations and limitations are confusing. If you do not actively track this, you could end up with a surprise at the end of the forgiveness period.”

Skloff’s website emphasizes that PPP loan recipients were given an eight-week forgiveness period.

“That time frame may not be calculated in the same manner as a monthly or weekly payroll,” he warns. “The PPP forgiveness and optimization tool gives you the ability to automate the payroll allocation and tracking process and allows you to view your weekly progress toward forgiveness.”

The tool also helps users track non-payroll costs and monitor reductions.

Another resource for advisers was published by the Division of Investment Management of the Securities and Exchange Commission (SEC). The division posted a question and answer guide tailored specifically to investment advisers applying for PPP loans.

According to the division, an investment adviser has a fiduciary responsibility to disclose to clients that it applied for a PPP loan, even if the application was denied.

The division says, “If the circumstances leading you to seek a PPP loan or other type of financial assistance constitute material facts relating to your advisory relationship with clients, it is the staff’s view that your firm should provide disclosure of, for example, the nature, amounts and effects of such assistance. If, for instance, you require such assistance to pay the salaries of your employees who are primarily responsible for performing advisory functions for your clients, it is the staff’s view that you would need to disclose this fact. In addition, if your firm is experiencing conditions that are reasonably likely to impair its ability to meet contractual commitments to its clients, you may be required to disclose this financial condition.”

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