Market Views: Is it time to head into active equity?
The coronavirus has had an unprecedented impact on economies and financial markets alike. It's also offered a trial by fire for active investment managers who have long claimed they best show their mettle amid market volatility.
Since the beginning of the year, the rapid spread of Covid-19 has caused massive collapses in stock markets across the world, only for most to then recover most or all of these drops during April and May. On Wednesday (July 8) the US's S&P 500 closed at 3,169.94, only 2.7% down on the 3,257.85 it stood at on the first trading day of the year. Yet at its lowest point this year, on March 23, it closed at 2,237.4, a 31.3% fall from the start of January.
Passive investors have had no choice but to cling on tight during this rough ride, yet during March there was a net inflow into exchange-traded funds, according to Morningstar. Meanwhile, astute active stock managers have had the opportunity to limit their downsides, and then to potentially recover faster and stronger than the market at large. And there were some active fund outperformers during the second quarter of the year, said Morningstar.
Indeed, with the pandemic set to continue wreaking economic havoc on the world for months to come, active fund managers are likely to have at least the rest of the year to demonstrate whether their decision-making is worth the fees they charge. Of course, the reverse is also possible – the conditions could underline just how uncompetitive many active managers are.
Could Covid-19's barrage of uncertainty help active fund managers in select areas to shine, or will it underpin the passive managers' mantra, that average performance is impossible to beat?
AsianInvestor has compiled views on this topic from investment experts who cover both active and passive investing.
The below contributions have been edited for brevity and clarity.
Paul Colwell, head of advisory portfolio group for Asia
Willis Towers Watson
The past decade has been a difficult one for active management. Equity markets have roared ahead, and most managers have failed to keep pace. However, the recent market downturn and elevated levels of volatility may offer skilled active managers an opportunity to outperform. Indeed, we believe now is the time for active management.
There are several factors to consider.
First, the global equity index is made up of over 1,600 stocks, yet the top 100 stocks account for nearly half the index. Mega-caps have been key drivers of performance. Portfolios that substantially underweight these stocks have likely underperformed. Owning a passive index exposes investors to this concentration risk.
Another point to note is that alpha is cyclical. The gap between growth and value stocks has persisted for quite some time and is now historically wide. Covid-19 and divergent economic recoveries from it, along with geopolitical and policy uncertainty, spell new opportunities for stock pickers to take advantage of relative-value opportunities.
Lastly, what drove the market up may well drive it down. The advantage of having exposure to skilled managers is that they can be more versatile and respond to changing market conditions more quickly in the post-Covid-19 world ahead.
Jean-Louis Nakamura, chief investment officer for Asia Pacific
We are positive on equities for the second part of 2020. However, we believe it is important to keep an eye on the nature of the market’s rally. Indeed, since March, global markets have experienced and overlapped two distinct dynamics.
The first one, triggered by the surge in global liquidity, remained quite healthy, driven mostly by institutional money while focused on the secular winners, namely tech and quality stocks, resilient companies with strong financials, leading market positions and pricing power and strong sustainability characteristics.
The second dynamic took place sporadically in second half of May/early June and more recently in early July when grapes of positive economic surprises boosted sentiment, leading to temporary surges in under-valued and cyclical securities, mostly driven by retail investors’ flows. While we doubt about the sustainability of this second dynamic, we believe its retreat should not threaten the robustness of the first one.
With this in mind, smart beta or thematic ETFs, focusing on quality stocks, cloud-computing industries, robotics or biotech could do part of the job at reasonable cost. However, given the early stage of some of those industries, relative to e-commerce for instance, active managers should be in better position to select the potential future leaders, while avoiding weak, non-sustainable or even “scams” business models – as experienced recently in Chinese e-education names or European dematerialised financial services.
Kevin Anderson, head of investments for Asia Pacific
State Street Global Advisors
Asset owners should construct portfolios with a combination of active and passive exposures. Using both investment styles enables investors to build a tailored passive low-cost core exposure benefiting from broad market liquidity while selectively employing active strategies which demonstrate consistency in process to outperform.
While it might seem intuitive that active managers should outperform during periods of market dislocation or high volatility, breadth and dispersion of sectors and individual stocks are more important ingredients to active stock-picking skills turning into outperformance.
The market shock in the first quarter of 2020 showed very high volatility but comparatively little breadth of returns compared to previous equity market dislocations – return dispersion among sectors was lower than in the tech bubble of 2001 and 2002 or the global financial crisis of 2008 and 2009 for example. Were such extreme volatility and higher correlation to persist, then it may prove a challenging time for active managers.
However, accommodative monetary policy and stimulus programmes are likely to reduce volatility from extremes. With significant uncertainty remaining in the post-Covid environment, there is potential to see a greater number of active managers generate outperformance. Nonetheless, in a low-yield environment, a passive and low-cost core holding should remain a key building block.
Report published on July 8: Is the coronavirus rocking the foundations of capital markets?
Common wisdom says that in times of crisis active managers should protect their clients’ capital better than indexed strategies would, since they can make active bets at sector or asset level.
Yet the share of global assets managed actively fell from 76% in 2003 to 44% in 2018, while alternatives rose from 9% to 17% and passive strategies from 9% to 23%, according to Boston Consulting Group’s latest Global Asset Management Report 2019.
Data are not yet clear on the standing of active funds during the coronavirus crisis. Further analysis will be required in a few months’ time to determine if active funds have been able to identify pockets of value or untapped growth that market indices could not.
As for whether active management will bounce back using this crisis as a catalyst, 42% of respondents to our global survey, conducted in April, thought this was unlikely, while 31% said active managers would benefit and prove their worth.
Regionally, investors in the most advanced capital markets (North America and Europe) were least optimistic about active management’s potential to recover with the crisis. Conversely, respondents in emerging markets – particularly South Asia, the Middle East and Africa – were in general more bullish about active management.
Joe Marsh contributed to this article.