Morningstar’s Rekenthaler on the one place active managers add tons of value

One reason I like closed-end fund investing is that most CEFs are too small for skilled institutional investors to devote time there: The small percentage of their portfolios wouldn't move the needle. So the majority of CEF trading is dominated by individual investors. Joe Investor is often fickle, selling in a panic and/or buying near the top. If you do your homework, you can spot great opportunities to buy low, generate above-market income and find other ways to build a great portfolio.

Morningstar's John Rekenthaler highlights a similar phenomenon in what he terms "lottery stocks." You'll have to read the academic study (linked from the article) for the specifics, but these are generally overpriced stocks with questionable businesses and small market caps. Rekenthaler is impressed by the extreme degree to which professional managers have been able to stand out in a group of securities where trading is dominated by individual investors with a lottery mindset. He contrasts that to blue chips and mainstream parts of the equity market, where "too many pros chase too few opportunities" and security selection skill is neutralized.

I thought this was a really interesting read in light of (1) all the discussion of the alleged dangers of passive investing, dangers which of course are real for professional managers' careers but debatable everywhere else, and (2) the notion that skilled active managers have to look outside conventional exposures in order to add value in modern equity markets.

Submitted July 11, 2017 at 03:03PM by BokenUnbroken


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