I agree that active fund management still has a good chance of outperforming passive. However, I do not agree that the old recipe of focusing on common stock picking is a useful approach. What should be the logic behind it, other than good stories for good marketing results on the back of the clients?
Due to overcrowding of stock picking, public markets are micro-efficient but macro-inefficient. Thus, focusing on picking of uncorrelated macro-factor investments should be a much better systematic approach to outperformance. This can be done through separating pure alpha from pure beta investments.
The full return potentials of macro factor investments can best be harvested through a fixed buy & hold allocation, rebalanced regularly, to
1) passive low cost index funds/ETFs for the market factor (pure beta) and
2) uncorrelated actively managed futures (CTA) funds/ETFs with an equity-like level of target risk and return for alternative beta factors (pure alpha).
CTA funds are intended to generate pure alpha returns through non-predictive futures trading strategies. The tried and true time series momentum strategy is mostly used. It applies the macro momentum factor to equity and bond indices, commodities, currencies...
In particular, this strategy can provide crisis alpha for the active fund manager to significantly reduce crash declines without opportunity costs.
Portfolio alpha can finally be achieved through rule-based rebalancing. Thus, the macro value factor is used as well, applied by active fund management. However, only a few highly specialized CTAs worldwide can reliably provide this valuable crisis alpha. This leaves no realistic chance to any garden trend-follower. The reason is that markets are efficiently macro-inefficient besides being micro-efficient.
Therefore, this approach is one of the most cost-effective for sustained outperformance as well as for risk mitigation, expected from active fund management. This is, because it focuses more than any other approach on the two most reliable, rich and independent sources of returns in the financial markets. Therefore, this approach uses the most cost-effective instruments:
1) Steady earnings from productive work and from other services as well as value appreciations of pure beta investments in the equity markets, using index funds/ETFs
2) Steady losses of other market participants due to their innate behavioral biases, in particular due to the herding drive, exploited and transformed to profits for the fund through CTA funds/ETFs
Achieving outperformance depends on exploiting losses from other market participants in a cost-effective and dependable way. Therefore, futures markets are used. They are between 10 up to 500 times larger and more liquid than equity markets. Moreover, futures markets offer the lowest costs a) for trading, b) for leveraging and c) for short selling.
In fact, cost-effective leveraged short selling is the most effective way to achieve relevant true alpha returns, absolutely independent of equity markets. Obviously, this is completely absent from any long-only stock picking as well as market timing approach.
Therefore, all these advantages as well as micro-efficiency of equity markets should leave no realistic chances for old school stock picking funds including Smart Beta. In fact, they are merely over-priced beta in disguise of alpha for good marketing. I also wonder, why this is proposed here in this educational blog.
Here a fine CFA article on this by Nicolas Rabener can be found. It contains details about this much more up-to-date systematic approach to systematic active portfolio management:
https://blogs.stage.cfainstitute.org/investor/2019/09/23/smart-beta-vs-…