Looking at the numbers, it’s not surprising that advisors, consultants, and institutional investors alike have become increasingly frustrated with the underperformance and high fees associated with traditional active equity management. Roughly 70%–90% of active managers in the strategic U.S. large, U.S. small, and international equity categories have underperformed passive providers over three-, five-, and 10-year periods, according to recent Morningstar data (see Figure 1).

Yet investors looking to optimize their equity allocations face a dilemma: Should they move to passive vehicles to avoid potential underperformance, settling for equity beta alone? Or maintain an active equity allocation but seek to improve the potential results? In an aging expansion where future index returns alone may no longer meet investors’ goals, we’ve found that many are opting for the latter path. But an additional challenge then emerges: how to identify managers with the potential to outperform more consistently, and at a lower cost.

In this environment, we believe investors need innovative strategies that move beyond traditional stock-picking. PIMCO addresses the challenges facing equity investors head-on, with award-winning¹ nontraditional equity approaches that seek to offer more reliable and diversifying sources of alpha potential at a lower cost than with traditional active management.

Unconventional solutions to common problems

While some traditional active equity managers do outperform their benchmarks, selecting a manager likely to outperform in the future is challenging. Simply relying on past results leads to performance-chasing, which may erode returns. And while studies suggest that high-active-share managers have greater potential to outperform, they also typically bring high tracking error, exceeding many investors’ risk tolerance.

Moreover, we see compelling arguments that active managers’ broad underperformance is structural, rather than cyclical. A dramatic decline in the number of listed stocks has reduced the opportunity set for stock-picking, and at the same time, a growing democratization of information and a rise in technology-driven trading strategies call into question whether stock-pickers can still gain a meaningful research advantage.

Given these realities, PIMCO developed different approaches to equity investing, with three main strategy pillars that we believe provide more reliable – and even structural – sources of excess return potential:

PIMCO StocksPLUS is a suite of time-tested “index-plus” strategies that seek to add alpha to various equity exposures using a nontraditional source of potential excess returns: bonds. By providing passive exposure to the investor’s target equity index through equity index futures or total return swaps, which require a minimal capital commitment, the majority of assets can be invested in a global, flexible high quality bond alpha strategy seeking to generate above-market returns. With potential for more consistent outperformance and a track record of more than 30 years, StocksPLUS may serve as a core holding within an equity allocation and provide important diversification benefits – a key advantage in late-cycle markets.

PIMCO RAE (Research Affiliates Equity) strategies are systematic, rules-based value strategies with an active investment process designed to deliver excess returns while maintaining broad diversification, economic representation, low turnover, and lower fees versus traditional active management. Value investing may offer compelling benefits in a maturing cycle, and the RAE portfolios are designed to consistently (and unemotionally) buy those stocks that are most unloved and sell or avoid those that appear overvalued. Investors with large exposures to technology and other sectors dominating growth investing today may consider RAE to be a logical complement.

PIMCO RAFI Dynamic Multi-Factor Strategies are smart beta strategies that seek to provide diversified exposure to select equity factors linked to higher returns, with a unique dynamic factor weighting methodology. Based on Research Affiliates’ Fundamental Index methodology, which weights companies based on fundamental size rather than market capitalization, these strategies offer allocations to value, low volatility, quality, momentum, and size. In addition, these factor portfolios are dynamically weighted, bringing a “buy-low, sell-high” discipline to factor investing.

Like all investments, these equity approaches come with risks, including declines in value due to both real and perceived general market, economic and industry conditions. However, the long track records for many of our equity strategies speak to PIMCO’s deep risk management resources and ability to navigate various market environments. In addition, Research Affiliates has been a pioneer in thoughtfully building and implementing rules-based equity strategies.

Innovative approaches, compelling results

For investors looking to improve their equity allocations by replacing underperforming active managers, PIMCO offers an array of equity solutions across regions, market caps, and styles. Our strategies are designed to benefit from what we view as more reliable sources of excess returns and to provide the potential for more consistent outperformance at a lower cost than traditional active equity managers. And our results have not gone unnoticed: PIMCO has won the Lipper Fund Awards’ Large Company Equity Asset Class category five times, including in 2019.

So when traditional approaches disappoint, it may be time to move off the beaten path and take a different approach to equity investing.