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Why a stock-picking 'renaissance' may be coming

The performance of active managers has generally sunk as passive investments have gained popularity, but one strategist sees the trend swinging back if interest rates rise this year.

"Judging from the past half century of data, it seems we are likely at or near a period of peak passive, with mean reversion to follow. Assuming interest rates rise meaningfully in 2017, we think active fund management should begin to recover," Joseph Mezrich, managing director and head of equities quantitative strategies at Instinet, wrote in a recent paper. "A renaissance in active funds may be coming."

Passive management is generally associated with sector-specific exchange-traded funds (ETFs), index funds and passive mutual funds, as opposed to active management, which is associated with stock picking.

In looking at the experience of active managers back to 1970, Mezrich found that each performance valley has been followed by a recovery of sorts, notably in 1976, 1998, 1987 and 1998.


He said much of his forecast hinges on the direction of interest rates, since they influence the performance of active funds given fund managers' "bias" to underweight high-dividend-yield stocks. Over the last 13 years, Mezrich found a negative correlation between interest rates and stocks' dividend yields.

"So we've been here before. And each time that's happened, it comes back," he said Thursday on CNBC's "Trading Nation."

"We've hit bottom and it may bottom here for a while, but the anxiety that managers have that it's 'game over' is not correct. This has been here before, and it's going to come up as rates come back up," he said, adding that if active management performance improves and interest rates rise meaningfully, capital will be driven out of passive vehicles and into active ones.

Investors had far fewer passive investment options in previous decades, Mezrich noted. Active managers in Instinet, the equity trading arm of Nomura Group, execute trades for asset management firms and may very well hope a renaissance is upon us.

"Throwing the towel in active management 'cause there's no hope for it is wrong. Will it turn around in the quarter? That's probably too much too soon, but over the next year, certainly going forward, we're going to see a renaissance, is the way I would put it, because of that bottoming process," he said.


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Brian Sullivan is co-anchor of CNBC's "Power Lunch" (M-F,1PM-3PM ET), one of the network's longest running programs, as well as the host of the daily investing program "Trading Nation." He is also a frequent guest on MSNBC's "Morning Joe" and other NBC properties.

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