Manager talent, costs and patience are the three key ingredients for successful investing in active strategies, according to Vanguard Asset Management’s Ankul Daga (pictured). 
Daga – a senior investment strategist at the group – said commentators had started to back active managers again after strong performance more recently. However, the strategist noted that active UK equity managers had underperformed in 2016.
Indeed, just 44 IA UK All Companies funds outperformed the FTSE All Share index last year as many managers were caught out by the shift from growth to value.
The Brexit referendum result also wrongfooted many managers with polls having forecast a victory for the remain campaign. After an initial sell-off by markets, UK stocks rallied strongly and were further buoyed by improved sentiment following the election of Donald Trump as US president.
Performance of sector vs index in 2016
Source: FE Analytics
Daga said: “History shows us that active outperformance comes and goes and past performance is certainly no guide to the future.
“Meanwhile, pundit predictions are often wrong and we can't be certain that market conditions will be conducive to active outperformance in the coming months.
“As such, it would be unwise to try to time entry and exit points for active management. Instead, investors should think about their long-term goals and attitude to risk.”
Daga said he was not ‘bashing’ active managers, highlighting the firm’s approach outside of the UK.
He said: “Vanguard is known primarily as a passive manager in the UK but, globally, active mandates make up over a quarter of our assets under management and we are one of the world's largest providers of active funds.”
Yet Daga said there were two points about active performance that investors should consider: “First, active managers need performance dispersion at the security, sector or market level in order to create alpha: if all stocks in all markets delivered the same return, it would be impossible to outperform.
“The current argument is that Brexit negotiations are likely to produce a period of heightened volatility and return dispersion, creating a fertile ground for active managers.”
He added: “While that argument makes sense in theory, in practice markets are very hard to predict. Memories of the Brexit vote and the 2016 US election remind us that markets often fail to follow the script provided by pundits.”
The strategist said it would be hard to predict whether performance dispersion would continue as Brexit negotiations continue, although it did seem likely that market volatility overall will increase.
“But let's suppose that markets deliver conditions that are ripe for active outperformance,” he said. “This brings us to the second point: talent.
“Dispersed returns don't guarantee outperformance; they simply increase the range of potential outcomes for active managers – on the upside and the downside.”
Performance of FTSE All Share since referendum
Source: FE Analytics
Daga explained: “To succeed, managers still need to demonstrate the skill to turn that dispersion into outperformance, through stock selection, sector strategy, geographical allocation and, in the case of bonds, credit research, maturity strategy and so on.
“In reality, few managers demonstrate this talent, particularly over the long term and especially after costs.
“But some do, and so the next challenge is to identify the ones most likely to succeed in the future.”
Finally, Daga noted that investors must exhibit discipline and patience, adding: “Performance persistence is difficult to achieve and even the best active managers suffer prolonged periods of underperformance.”
Patience and the emphasis on long-term asset allocation was highlighted more recently by outgoing Vanguard chief executive Bill McNabb, who pointed to recent geopolitical events and the potential for greater volatility in markets.
He said: “We’ve seldom witnessed such overt concerns from our clients regarding geopolitical issues: North Korea, Catalan secession, continuing instability in the Middle East and events in the US.
"What we're hearing is that all of these negative events are causing some clients to reconsider the wisdom of a long-term asset allocation.
"They believe that the market is poised for significant volatility, so they're thinking about getting out.”
Performance of MSCI World index YTD
Source: FE Analytics
Despite some of the destabilising events in markets, the MSCI World index has continued to climb higher and is up by 9.27 per cent so far this year, as the above chart shows.
Volatility levels have also remained lower, prompting some concerns among investors over a potential spike.
McNabb added: “The thing is, when markets respond to external events, they do so very quickly, and getting the timing right has proved impossible.
“With market timing, you have to know the answers to two questions: When exactly do you get out? And when do you go back in?
“Experienced investors know that keeping a long-term view is key to investment success. That's a difficult message to hear and, for some investors, an even harder one to live by when uncertainty hits, but it’s the wisest course of action.”