Interview any finance graduates on their career aspiration and you are likely to get one of two career paths: become an investment banker, or take up a role as an investment analyst and eventually becoming a portfolio manager. The lucrative salary and prestige of these highly coveted jobs are often the main contributors to graduates’ career decision.
However, reports have shown that the majority of the actively managed funds across all asset classes have failed to outperform their benchmark (usually the index) consistently. This means that an investor is likely to be better off investing on index-tracker funds since active funds do not consistently provide any value-add.
So why should any finance graduates strive towards a role that does not provide any value-add to the economy? Is it really true that portfolio managers are not providing any value-add to the market?
Portfolio Managers Do Value Add, But Only If They Do it Right
1. Active Fund Managers Perform Better In Less Efficient Markets
It is easier for active fund managers to outperform in markets that are less efficient. An article from Wall Street Journal suggests that this is because active fund managers are faster to react to new information. Less efficient markets refer to sectors or stock markets where information are less accessible. Therefore, active funds tend to outperform in small market capitalisation (small-caps) stocks and emerging market as there are less news or analyst coverage on these areas.
In these instances, having an active fund manager who is familiar with the market and has insights to the sectors can provide value for investors.
2. Real Active Fund Management Supports Innovation
Real active funds such as venture capitalists and private equity funds provide funding for new business models, which in turn provides future benefits to the economy. Think of Uber, Snapchat and Airbnb. All these technology companies initially source their funds through venture capitalists, in which they provide funding and expertise to help the companies grow into what they are today.
3. Active Fund Provides Liquidity In The Market
A study by the Federal Reserve Bank of Cleveland shows that hedge fund tends to reduce, rather than increase, the volatility of assets by going against prevailing wisdom and taking contrarian positions. Hedge funds do not reinforce asset bubbles, instead, they tend to prevent them.
Markets also tend to be more efficient when investors employ different investment strategies. Imagine a time of distress, where people are all rushing to sell stocks. Who would end up buying the stocks if everyone is thinking the same way? Markets often overreact and passive funds are forced to rebalance their portfolios, obliged to replicate their benchmark. Hence, by selling irrationally overvalued stocks and buying irrationally undervalued ones, active funds are the ones that help in a market correction.
A quick glance at the situation might suggest that portfolio managers are not worth what investors are paying for, and that the job does not provide much value to the market. However, these active fund managers do provide values to the economy if they are in the right economy and are employing the right strategies. Hence, graduates can continue to strive for this job if they can are constantly able to provide insights to less efficient markets.
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