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Investors look to active management to navigate increasing volatility

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Some 63 per cent of professional US investors expect an increase in market volatility over the next 12 months, according to the MFS Active Management Sentiment study.

And whether market volatility over the past month is temporary or a sign of things to come, 70 per cent of professional US investors surveyed call protecting capital in down markets one of the most important attributes when considering an active manager. The study, which was conducted by the research firm, CoreData between April and June of 2015, includes insights from 1,083 financial advisors, institutional investors and professional buyers around the globe, including 575 respondents in the United States.

"At some point, we will see additional volatility and that creates opportunity for active managers to identify risks and generate alpha," says Joe Flaherty, chief investment risk officer at MFS Investment Management. "Downside risk management is part of the value proposition that active managers can deliver through research and security selection. Many active global managers have significantly outperformed in falling markets."

Investors recognise this capability. In the United States, 63 per cent of those surveyed believed actively managed strategies work best in falling markets. Evidence supports their conviction. Over the past 25 years, the top quartile of active managers has added 7.6 per cent in excess returns in falling markets.

Downside risk management may garner more consideration from investors following the S&P 500 Index's rise of over 200 per cent since the end of the global financial crisis in March 2009. Despite significant flows into passive investment strategies in recent years, only 38 per cent of US professional investors surveyed are highly confident in passive management and surprisingly, only 6 in 10 investment professionals said passive investments have no ability to adapt in volatile markets.

"A passive strategy, by definition, takes full market risk. In recent years, strategies that straddle the line between active and passive have become increasingly popular with investors," says Flaherty. "And while that shows some desire for active decision-making on the part of investors, many of these strategies are fairly new and have not been tested during a sustained downturn in the market."

Professional investors surveyed highlighted risk management, long-term conviction and research expertise as the most important attributes in identifying skilled active managers. In the United States, 83 per cent of survey respondents indicated that a firm's active risk management process is the most important trait of a skilled active manager. Many active managers have shown the ability to outperform the markets over full market cycles, which is typically measured from market trough to trough (There's No Substitute for Skill, MFS Investment Management, June 2015).

"We believe there are clear signs of a skilled active manager — establishing and adhering to disciplined research and portfolio management processes, demonstrating long-term conviction through differentiated portfolios and long holding periods, and adding value in volatile markets," says Mike Roberge (pictured), Co-CEO of MFS Investment Management.

An active manager's ability to develop convictions matters. Among US investors surveyed, 67 per cent pointed to active security selection as the most important attribute when considering an active manager, while 64 per cent thought a robust investment research platform is very important.

When considering the merits of active management, particularly in light of recent market conditions, respondents called short-term thinking one of their top concerns. In fact, 68 per cent of survey participants worldwide said investors are too focused on short term investment returns (12 months). It's not surprising then, that investors are willing to pay for strategies that can provide strong long-term results. In the United States, 82 per cent of professional investors surveyed said they are willing to pay more for outperformance over five years while 68 per cent said they are willing to pay more for managers who can outperform over 10 years.

"It's difficult to deliver significant outperformance over short time periods without taking a lot of risk," says Roberge. "Actively managed investment strategies aim to deliver outperformance over a full market cycle, which includes both a bull and a bear market. Differentiated security selection and patient investing are the keys to delivering risk-adjusted returns."

From 1995 to 2013, portfolios with the highest active share — or differentiation from their benchmarks — and low portfolio turnover have outperformed their benchmarks by 1.9 per cent.2

Despite recent passive flows and some headwinds, active management appears to remain the preferred approach for investment professionals, with 60 per cent of US professional investors surveyed indicating that actively managed strategies will play a significant role in their portfolios in the future. Of those surveyed, professional investors in the United States have allocated 77 per cent of their assets under management to active investment strategies. US investors said they will continue to allocate the majority of their assets (68 per cent) to active strategies over the next five years. More than half (52 per cent) of all survey respondents said they are highly confident in active management.

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