Why active managers need to deploy hedge fund tactics

by Michael Msika

Active investment managers have no option but to adopt hedge fund strategies to counter the migration to low-cost passively run portfolios, according to an outperforming French asset manager.

They need to shift to greater use of techniques such as mathematical models, algorithms, derivatives and hedging, said Olivier Nobile of Arkea Asset Management. That will increase the chances of offering index-beating returns and greater protection for investors during downturns, said Nobile, whose firm is a unit of Credit Mutuel Arkea, which has $55 billion under management.

Two of Nobile’s largest funds, Arkea Focus Human and Arkea Focus European Economy, have outperformed nearly 90% of their peers this year, while offering lower volatility, according to data compiled by Bloomberg. The funds are up 9% and 18%, respectively, compared to an 12% gain in the Euro Stoxx 50 Total Return Index.

“We are firmly convinced that the active equity management of tomorrow will only be hedge-fund like, that is to say with a combination of quantitative and fundamental drivers, and real management of extreme market risks via permanent hedging,” Nobile, a manager of thematic investments at Arkea, said in an interview. “This will allow fund managers to present a very different risk profile from passive equity management.”

Investors have flocked to exchange-traded funds and other forms of passive asset management over the past decade. Their relatively low costs and attractive liquidity have made it harder for active fund managers to justify their fees as they struggle to beat typical equity benchmarks or outdo portfolios tracking large-cap stocks.

Only 14.2% of active managers in Europe beat passive strategies over the past 10 years, according to research and analytics firm Morningstar Direct. The global fund universe was split roughly between 56% active and 44% passive by the end of May. 

“In equity markets, active managers face a particular challenge when returns are concentrated in the largest index-weighted stocks,” said Eugene Gorbatikov, a passive strategies analyst at Morningstar. “Large-cap stocks have led the market in recent years, making it especially difficult for active equity managers to outperform after fees.”

Arkea’s Nobile said boutique firms will lack the economies of scale to compete with large asset managers as their fees come under pressure. The only way to justify charging clients more will be to offer products that stand out, by using hedge-fund like strategies that seek to protect portfolios during extreme drawdowns, while not detracting from performance when markets are rising.

A quantitative analysis approach, like those followed by hedge funds, will also allow portfolio managers to be more active, using buy and sell signals based on multiple price action indicators. The hope for advocates like Nobile is that investors will feel confident that they don’t have to worry about market timing because these models assess when best to increase or cut exposure, while offering some protection. 

Arkea launched a series of thematic funds at the end of 2022, which all carry so-called overlays, a bespoke and underwritten strategy intended to manage specific risks and enhance returns.

Stress tests simulating a 2008-like market crash show about two-thirds of the drawdown would be offset by the hedging strategy, Nobile said.

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