Active fund managers are less skilful in the short term than top tennis players who have a far greater success rate, according to Liontrust Asset Management’s John Husselbee. 
Using three measuring factors – cause & effect, mean reversion, and prediction – the Liontrust multi-asset head said it takes more skill to play tennis than it does to outperform as an active manager, with success for the latter being more down to luck.
Indeed, the number one seeded men’s tennis player, Rafael Nadal, has a 92 per cent winning average on clay. Husslebee (pictured) said that provided Nadal’s fit and healthy he has “pretty damn good chance of winning tournaments”, meaning that the cause & effect was pretty strong.
Nadal has also been in the top-10 since 2005, giving him a weak mean reversion measure.
If you put an active fund manager through the same testing, said Husselbee, the result is the opposite.
Putting an IA UK All Companies sector fund through the cause & effect testing over the short term, Husslebee said the probability of outperformance stood at 52 per cent.
He explained: “52 per cent is like the toss of a coin – a 50/50 chance – heads or tails over the short term. Cause & effect therefore must be fairly weak.”
Cause & effect in the short term
Source: Liontrust Asset Management
Going on to mean reversion Husselbee said that in the short term, “there’s plenty of it in terms of fund management,” meaning that funds will usually move to the average returns range.
On prediction, Husselbee found when calculating the likelihood of a top-quartile fund remaining top-quartile that in the UK All Companies sector just 42 per cent of managers outperforming over a three-year period outperform over the following three years.
Short-term prediction
Source: Liontrust Asset Management
“Let’s round it off,” he said. “It’s 50/50, No more than a toss of a coin. Therefore, in terms of prediction, I would suggest that it’s fairly weak.”
He added: “So, if you look at tennis – which I think we will agree is all about skill – if you take those three tests, then you would find strong cause & effect, weak mean reversion and strong prediction.
“Therefore, you would say, in the test, there’s real evidence of skill.”
This is not to say that active fund managers are not skilful, Husselbee clarified, because in the long run their styles and allocations are what drive their outperformance.
But in the short term their performance is simply more determined by investment style – value versus growth, for example – then market cap, and thirdly noise, namely geopolitical events and day-to-day sector news.
Looking at the first two elements, Husselbee in his own multi-asset range avoids the extreme value and growth deep ends where the biggest risk is found.
Going into the history of style performance in markets and as Husselbee’s “quilted” table shows that whilst styles over the long term can outperform, “year-in, year-out it can be all over the place”.
Investment styles timeline in markets
Source: Liontrust Asset Management
“In 2016 small-cap value – the dark blue box – that was the best performing of all the styles,” he said. “In 2018, [it was] the worst performing of those styles – it was at the opposite end.
“And as I said when trying to find a pattern there isn’t one, believe me I have been doing for 30 years and I haven’t found it.”
And the final thing is market noise which Husselbee said, a manger has to decide whether or not that noise is relevant. And if it is then is it investable and is it the right time to act on it.
“Day-in, day-out, managers are making those decisions,” he said.
“Management can basically be skilled or unskilled, and I think you can probably add a further axis on which is basically lucky or being unlucky.
“And it’s for those reasons and investment style and market noise, I think is what drives funds in the short term.”
However, that is not the case when you examine the same IA UK All Companies sector examples over the long term.
Although there’s only a coin toss chance at outperformance in the short term, “once you get to seven years and 10 years, 100 per cent probability for outperformance is there”.
The multi-asset manager said: “Cause & effect seems to be a lot stronger than it is in the short term. Mean reversion is a lot weaker than it is in the short term. Prediction is a lot stronger than it is in the short term.
But that short-term performance cannot be ignored. And whilst patience is required in allowing an active fund manager to bring in long-term results, Husselbee said, passives can bridge that gap.
“When we build portfolios we blend them with active and passive,” he explained. “In fact, I think passives is one of the best things that has happened to managing portfolios services such as ours.”
Husselbee said the multi-asset team can use tracker funds to reduce or increase their asset allocation weighting whilst patiently leaving the active funds to do what they’re supposed to and let them build up their prediction and cause & effect over time with their processes.
“So, in the case of actives versus passives, I would totally agree with you that passives will do its job in the short term,” the manager said. “Because you can leave management to do what they’re supposed to do [over the long term].”