2022 was an annus horribilis for active funds, where
expert active managers sift through a market to
construct a portfolio of the best stocks it has to offer.
According to investing broker AJ Bell’s Manager versus
Machine report, after fees just a quarter (27%) of active
funds beat their passive equivalent, in which stock
market indices — the benchmark against which active
funds are compared for performance purposes —
are simply copied.
It comes hot on the heels of a decade of investors
shifting into passive strategies. In the US, where much
of the global stock market resides, 10% of total assets in
US mutual funds was allocated to passive strategies at
the onset of 2010; by the end of the 2022, it was 25%.
The allure is simple: while it isn’t possible to outperform
the market, passives offer investors the opportunity to
access stock market returns for very little cost and drag
on their returns.
Since 2022 however, long-term market conditions have
been evolving, as we move into an era where inflation
and interest rates are likely to be structurally higher,
and stock market volatility elevated for some time to
come. It’s changing the playing field for active managers,
and begs the question: as markets become choppy
and unchartered, could now be the time to consider
an experienced captain to navigate your investments
through the storms?
Here are six reasons why we believe the era
of active may have arrived:
01
Inflation and slowing economies create stock market winners and losers
Last year we saw sharply rising interest rates
alter the relative values investors were prepared to pay
for shares. This year, the driver of stock markets may
shift towards news flow surrounding company profits.
Given that high inflation and slowing economies will hit
company profits in varying ways, it implies a wide range
of stock returns is likely.
It points to a need to separate the troubled companies
that face existential threats from those with a brighter
future. Active managers will be able to find companies
that can navigate a tricky trading environment by
identifying qualities such as strong pricing power,
profits and profit margins, and low levels of debt.
02
New investing ‘styles’ come into vogue
In the decade running up to the start of 2022,
stock market returns were dominated by
a handful of mega-sized technology businesses,
particularly in the US. This trend may be about to go
into reverse for an extended period: the winners of the
last decade may face continued selling, and areas of the
market that had stagnated in the former market regime
may do much better, for example cheap ‘value’ stocks.
Given the new market order, winners are likely to be
found in various corners of the market, and it will take a
discerning eye to find them.
03
Profits likely to fade for some companies
For more than a decade, globalisation, low
inflation, and cheap money spurred an era
of ever-higher profits for companies, and now they’re
looking vulnerable. As economic growth slows and costs
rise, profits are likely to become increasingly squeezed,
which may affect share prices. Experienced active
managers will be needed to find companies that can
sustain profitability.
04
US loses its dominance
In the former market regime, US markets
outperformed non-US markets in eight out
of the past ten years, largely on account of its heavy
weighting towards popular ‘growth’ stocks. In the new
regime, given that inflation is impacting countries in
varying ways, a global investment approach, with asset
allocators who can direct portions of the portfolio’s cash
into different markets depending on how the economy is
being impacted, will be needed. You typically won’t find
this with passive global strategies.
05
Volatility makes for an active managers’ paradise
We need shares if we are to beat inflation
and yet stock markets are likely to remain volatile.
According to data from index provider MSCI, stock
volatility is above average in all major regions across
the globe, bar Japan.
Big differences in stock valuations mean active
managers can find cheap companies that have a
chance of performing strongly over the long term,
while avoiding those that appear overvalued and
expensive. What’s more, the last two occasions when
variations in stock valuations were as wide as they are
now, were the tech bubble at the dawn of the millennia
and the global financial crisis — following both periods,
active managers went on to do well.
06
Fee hurdles reduce
Passive funds are cheap by design, and the
impact has been to drive down fees across the
whole industry including active funds. As a result, active
managers find themselves having to leap over a smaller
hurdle of fees when comparing their performance to
the index.
It needn’t be tempestuous
Journalists and commentators have long indulged in
‘active versus passive’ debates, often portraying the rise
of passives as stoking an existential fight between two
sides of an industry. In truth, many investors appreciate
that it is not an either/or situation — our portfolios are
likely constructed best through a combination of both.
That said, in a bygone era of cheap money and low
interest rates that have raised markets more broadly,
passive has been favoured. Since 2022 however, higher
inflation and interest rates are changing the status quo,
with markets becoming a choppy sea of winners and
losers. So an experienced captain is likely required.
Enter the era of the active manager.
How WTW can help
We have tapped into our skill in high-conviction
manager selection developed over many years
and leveraged our global research team to find
very talented concentrated stock pickers around
the world. We then take their highest conviction
idea portfolios (typically 10 to 20 stocks) and blend
them such that the overall strategy does not take
significant bets on either country, sector or style
exposures. This approach focuses on maximising
return potential from managers’ stock selection skill
with a prudent risk oversight. We have launched
a fund to house this investment approach, aiming
to ensure we can bring further cost savings to our
clients by pooling assets and using our buying
power to negotiate hard on fees. We believe
this approach can generate long-term improved
performance for asset owners.
Disclaimer
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Canada
About Integra Capital Limited
Integra Capital Limited (”ICL”) is a wholly owned WTW company which
provides portfolio management, dealer and settlement services. ICL is
registered with the Provincial regulatory authorities, the Yukon and Northwest
Territories as a portfolio manager and exempt market dealer; as a registered
investment fund manager in Newfoundland and Labrador, Ontario and
Quebec; and as a commodity trading manager in Ontario.
US
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does not take into consideration individual circumstances. The information
contained herein should not be considered a substitute for specific
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respective directors, officers, and employees (WTW) to be construed as the
provision of investment, legal, accounting, tax or other professional advice
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of the Internal Revenue Code.
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performance is not indicative of future performance. In producing this
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