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Emerging managers maintain performance edge in US equity investing

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A study by Northern Trust suggests that smaller investment firms can provide stronger returns and better downside protection in volatile markets than large firms investing in the same asset class – large-cap US equities.



“Our new study indicates that emerging managers may help investors squeeze more out of their most important, and most challenging, asset class,” says Ted Krum, investment programme manager for the programme solutions group at Northern Trust Global Investments, the asset management arm of Northern Trust. “Despite market declines and portfolio reallocations, US equities still make up the largest portion of many institutional client accounts, making this asset class a key driver of performance for institutional investors.”

According to Northern Trust’s new research, titled No Contest: Emerging Managers Lap Investment Elephants, investment firms with less than USD3.6bn under management – the smallest firms that collectively manage one per cent of all assets in the institutional market – outperformed the largest firms and all other groups studied, as well as the S&P 500 Index, over the five-year period ending 30 June 2010.

Northern Trust examined eVestment Alliance performance data for large-cap core US equity products managed by 284 investment firms of all sizes, with total assets under management of USD12.3trn.

Firms with less than USD3.6bn under management gained 0.67 per cent per year in their active large cap US equity portfolios for the five-year period, a higher return than larger firms or the S&P 500 Index, which was down 0.80 per cent per year over the same period.

Small firms tend to reduce risk when it counts the most – in bear markets. The emerging manager composite outperformed the S&P 500 Index in five of the eight bear quarters over the past five years by a cumulative 3.65 per cent – the best results of the groups studied. They were also the only group with total volatility less than the index (18.1 per cent per year versus 18.5 per cent).

The median small manager outperformed the median large firm by 72 basis points per year, which translates to an advantage of more than USD7m on a typical USD200m institutional allocation over five years.

When all active large cap US equity products are pooled into a single universe, emerging managers make up 44 per cent of the top performance quartile and only 28 per cent of the bottom quartile, while comprising 36 per cent of the overall pool of managers. Large firm results are skewed in the opposite direction, with a smaller share of the top quartile and larger share of the lowest quartile compared to their weight in the pool.

“These results suggest that clients can increase their chances of hiring a potential winner by expanding their search into the emerging universe,” says investment programme manager John McCareins, who works with clients of Northern Trust Global Investments’ programme solutions group that use emerging manager solutions. “With continued consolidation in the asset management industry, the largest firms effectively are the financial markets in which they operate, in terms of assets and transactions. These firms may have difficulty stepping aside when the market enters a downdraft, but we believe that small entrepreneurial firms can benefit at such times from management focus, rapid decision processes and fewer liquidity constraints.”

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