Signals for active management

October 5, 2020

In our first paper, Is the Performance of Active Managers Still Cyclical, we highlighted how there are cycles in active management and that certain market regimes (e.g., negative markets, markets with more breadth) tend to provide more fertile ground for potential active manager outperformance.

As a follow-up, we decided to search for potential leading indicators that could signal favorable regimes for active managers. These indicators could theoretically be used as guideposts when making decisions on allocating between active managers and passive indices. While these signals would not represent the totality of decision inputs on active versus passive allocations, they could theoretically help stack the odds in one’s favor.

We tested a number of potential indicators. Some of the hypotheses were more intuition-based while others were aimed at identifying possible leading signals of down markets based on data from our first paper that demonstrated the downside protection that active management has tended to provide in declining markets.

Our conclusion is that, outside the well-known leading indicators of recessions, the hypotheses were either proven false or exhibited too much noise to be considered reliable. In this paper, we review a sub-set of the tested hypotheses, their results, and the inherent challenges in drawing definitive conclusions on timing allocations between active and passive management.