Covid-19-driven market distortions have prompted discussions that active asset management may have a competitive advantage during times of volatility over passive strategies. But respondents to a survey by investment professionals association CFA Institute do not think so.

Of the total respondents, 42% said it was unlikely the crisis would reverse the steady shift into passive investments from active investing, versus 31% who felt it could lead to a reversal in favour of active strategies, according to the study to be released today by CFA (July 7). 

To assess the effects of the pandemic on the global economy and the asset management industry, the US-based association for investment professionals had polled some 13,000 of its charter-holders between April 14 and 24. 

Investors in the most advanced capital markets of North America and Europe were the least optimistic about the outlook for active management, with 46% and 43%, respectively, backing a continued shift into passive investing (see chart below). 

Mary Leung, CFA Institute

“This could be because these markets are already most efficient and also where expansionary monetary policy has been the strongest,” said the CFA study. 

Conversely, respondents in emerging markets – most notably South Asia, the Middle East and Africa – are in general more bullish about active strategies’ capacity to rebound.

One argument for this is that central bank intervention and quantitative easing have wreaked havoc on the normal process of value creation and assessment that occurs in financial markets, the study showed.

“What we have heard is that perhaps after this crisis, asset gathering may be accelerated [among the biggest passive asset managers],” Mary Leung, Hong Kong-based head of advocacy for Asia Pacific at the CFA Institute, told AsianInvestor

Indeed some feel that challenging market conditions, including extreme uncertainty and price volatility created by the pandemic, could accelerate an existing trend among asset owners: using passive funds to invest in mainstream assets.

ASSET MISPRICING

Based on the survey, a resounding 96% of respondents globally believe Covid-19 results in mispricing of equities and bonds. Liquidity dislocation and government interventions were cited as the top reasons driving asset price distortions.

“If the central bank keeps buying [assets], it means the asset price is not determined by the market but by the government. They wonder whether the asset price truly reflects the underlying value of the asset,” said Leung.

HOW LIKELY IS IT THAT COVID-19 WILL REVERSE THE STEADY
SHIFT INTO PASSIVE FROM ACTIVE INVESTING?
(Source: CFA; Click for full view)

Respondents in Asia said their biggest concern was about liquidity dislocations (cited by 45% to 48%, depending on the sub-region). In Europe and North America, investors were most worried about public authorities distorting prices (with 39% citing that as a concern).

While government interventions help stabilise markets, respondents were concerned that such measures could inflate asset prices, particularly in developed markets, Leung said. That said, rising mispricing risk tends to lead to more arbitrage opportunities, so diligent investors can be rewarded, she added.

Central banks in the US and Europe have been pumping liquidity into the markets to counter the challenges posed by the pandemic. For instance, the US Federal Reserve said in mid-June it would begin buying a broad portfolio of corporate bonds to support market liquidity.

LIQUIDITY RISK

However, the CFA study flagged that emerging market held greater liquidity risks than their developed peers during the coronavirus outbreak (although some risks, such as those of corporate defaults, are seen by some investors as lower in Asia).

While central bank stimuli in emerging markets are seen to have a limited impact on asset prices, a lack of liquidity is nevertheless depressing asset prices in those regions, resulting in higher asset-mispricing risks, Leung said.

Liquidity risk could aggravate asset-liability mismatch risk and counterparty risk, she added, and such risks are more pronounced for investors that may have more leveraged portfolios.

In a study released by asset management and custody firm State Street in April, 48% of 250 asset owners globally said liquidity was the second biggest challenge during the Covid-19 crisis, after timely reporting.  

Defined benefit pension plans, for example, need cash on hand to pay member benefits. Yet in a volatile market, such as during the crash in March, demand for usually liquid assets was subdued, and illiquid investment deals stalled, Ian Martin, global head of asset owner segment at State Street, told AsianInvestor.