It’s the age-old conundrum: as an investor do you take a hands-on approach – often throwing money at investment managers – to actively seek out alpha or do you take a passive approach by buying index and other mutual funds?
In the case of Australia’s Future Fund, until now a largely passive management strategy has been all it’s taken to propel it past the $A200 billion mark for the first time since the sovereign wealth fund was launched in 2006.
However, at a media briefing last week to announce the fund’s portfolio update, the fund’s chief executive Raphael Arndt signaled that the group needed to prepare for the end to ultra-low interest rates.
This, he said, would mean a switch to more active strategies.
“The return you get for just having capital and holding assets is going be less going forward because we've got headwinds in terms of lower economic growth and rising interest rates,” Dr Arndt told the briefing. “Things like ETFs, index positions, bond positions, reward you for having capital and being willing to take risk, but broadly that's all they do,” he said.
“We think there's still a place for those things, but it's not going be as important in generating returns as it has been over the past decade when we had the tailwinds of falling interest rates.”
He said that going forward the fund would need to access investment skills through investment managers. “For us that's going be primarily through private equity infrastructure, property, and hedge funds.”
This, however, needs to balanced against the expense of active management which Dr Arndt said was already a feature of the fund’s alternatives portfolio.
“We have a lot of active management over equities, but that primarily sits within our alternatives portfolio - within the hedge fund strategies - because we don't think it's cost effective for long-only equities managers to be active given what they charge and the amount of skill they can bring - it's a very blunt tool.”
TECH UNDER PRESSURE
With a large tilt to value and quality stocks, Arndt argues the two categories are set to outperform in a rising inflation, rising interest rate environment relative to growth.
“Tech companies are the ones that are going come under the most pressure and the reason for that is that it's becoming more and more expensive to hold positions that don't generate any income where the return are out in the never, never.
“Those companies (that throw off cash and real revenue) will become increasingly attractive and we’ve seen a little bit of a rotation even if we’ve been holding some of those positions for years.”
While active investing has its proponents, some investment managers still hold to the dictum articulated in Burton Malkiel’s 1973 book, “A Random Walk Down Wall Street” in which he argued that “a blindfolded monkey throwing darts at the stock listings” would do as well as professional managers.
Pioneers at firms including Wells Fargo and Vanguard Group developed index funds aimed at garnering average returns based on a broad swathes of the market by which most investors – by spending less on fees – would do better.
FLYING CLOSE TO THE SUN
An Australian-based private equity investment manager told AsianInvestor that the arguments for and against active versus passive investing are still as current today as they were 50 years ago.
“Active strategies usually have a philosophy or sector focus – it will be value stocks, tech or big pharma – but these go in and out of style and, of course, price/earnings multiples,” he said. “When they are hot they have momentum – you only have to look at tech which has been the darling of active investors.”
He said fund managers only needed to look at the recent travails of fund manager Cathie Wood - who became a superstar in 2020 after her ARK exchange-traded funds earned some of the highest returns in history – to see how active managers can often fly too close to the sun.
“Hero for years but ARK is now down more than 50% this year,” he said. “Meanwhile if you take energy, it’s been a disaster for years but it’s now a stand-out performer.”
He said he would normally back bulk investment tied to indices with just 20% in value investing.
“Value investing makes sense,” he said. “Gurus like Warren Buffett do their research and uncover gems, but a lot of active investing is simply doubling down on momentum investing. As we’re seeing with tech now, the hot theme of the day can be risky.”