Michael Wilson explores the background of the active versus passive debate
For Santander Asset Management's Tom Caddick on the need for a 'Local Butcher' , see www.ifamagazine.com/featured-news/why-we-need-the-local-butcher-297186
How We Got To Here
For many investors, the 2008 stock market crisis came as a signal to pull back from active risk-taking, and to settle down and let ‘the market’ decide where to take their investments. And that was probably what drove the trend toward passives that characterised so much of the late noughties.
It wasn’t just that those years were an era of high correlation between various markets and asset classes – if we exclude soaring bond prices, of course – and that you’d have to be pretty good to find value in many parts of the equity market, or anywhere else for that matter. Unfortunately, investors were also being told some uncomfortable truths about active managers – such as that fewer than 5% managed to beat their benchmarks.
Even hedge fund managers, the wild roving animals of the investment world, were getting into the same situation. And there were some well-publicised disappointments from star investment trust performers like Fidelity’s Anthony Bolton, whose Fidelity China Special Situations fund ran into a thicket of Chinese obscurantism that gave poor Mr Bolton more special situations than he was really prepared to handle – by late 2011the Fidelity fund had dropped 27% below its May 2010 issue price and has only recently recovered.
Now, some of those dismal reports about underformance were apocryphal, of course – the best fund managers have always been able to outperform their peers. But the relentless rise of trackers, primarily exchange traded funds, was accompanied by a stiff downward pressure on management fees that also helped to drive business away toward trackers.
Taking Back the Flight Controls
That’s where it might have remained, had the equity market not picked up and the overpriced bond market finally come to its senses. The last couple of years have seen a sharp revival of returns in certain sectors and certain markets – the most telling being, perhaps, smaller companies and the indomitable US stock market. Whereas, at the same time, some of the ‘sure bets’ in China and Latin America have been eroded by some highly company-specific issues that any talented manager with on-the-ground intelligence could probably have spotted in advance.
All generalisations are false, as the annoyingly self-contradictory saying goes, but it still remains generally true that equity bull markets will tend to bring out the opportunities that flatly-correlated markets will normally suppress. Quite simply, under these circumstances stock-picking becomes worth the gamble again.
We saw this last year, when a study by Winterflood analysed the performance of closed-ended funds against their open-ended counterparts, and found that investment trusts had outperformed during the year to November in fully 13 of the 16 market sectors. You’ll find the article in the February issue of IFA Magazine, or at www.ifamagazine.com/featured-news/investment-trusts-racing-ahead-292731.
And as Annabel Brodie-Smith from the Association of Investment Companies told IFA last month, the average investment company had put on 7% during the year to end-January 2014, 20% over three years and 104% over five years. That’s comfortably more than you’d have got from a Footsie tracker. (www.ifamagazine.com/featured-news/investment-trusts-and-shrinking-discounts-295559)
No Need for Dogma
But, as we’ve been reminded at several of IFA Magazine’s Adviser Seminars recently, there are more options than simply stock-picking for a manager who wants to outperform. The profusion of new and sophisticated ETFs has thrown up the possibility of backing, say, an ‘enhanced beta’ fund that stands to prosper if a particular outturn should happen – for instance, if companies with high debt or small turnovers or a lot of business with China should do well.
Naturally, an ETF is always a passive instrument – but perhaps it’s passive to different things from other funds. And yes, by selecting enhanced beta funds in a targeted way, a manager can skew his portfolio so that he’s taking an active position on certain outcomes. If you see what we mean?
Other managers are finding that specialising in large-cap companies with big dividend payouts can slice the top off the egg in a particularly advantageous way. Yes, there are more ways to play the active management card than a simple stock-picking approach might suggest.
But in conclusion, as Santander’s Tom Caddick has already pointed out, the wisest approach for an adviser is to be open to all possibilities and to resist getting wedded to one camp or the other. Every one of your clients has a different risk appetite and a different forward profile – which means that the right solution for any client is likely to require personal tailoring.
And So to the Local Butcher
By keeping the advantages of actively-run portfolio elements permanently in mind, a skilled adviser should be able to pick up on the performance strengths of the active selection process without succumbing to undesirable levels of risk. But you probably won’t find that kind of commitment from a general-purpose, one-size-fits-all, commoditised, sanitised, supermarket-style product that’s been designed for a million customers. For better than that, you need the strength and personal knowledge of the Local Butcher.