Will the pendulum swing back in active managers’ favour?

8 February 2019

Exchange-traded funds (ETFs) have enjoyed a decent uptake in investor interest in recent years, driven in part by the extended bull market. 

Just last year, the now $41 billion Aussie ETF industry added over $5 billion in assets, following a similar pattern to the global ETF industry, which now sits at US $4.8 trillion. 

Hamish Tagdell, portfolio manager at SG Hiscock, estimated from the bottom of the GFC (2009) through to about 2015, the market return through that period was close to about 15 per cent per annum, versus a 25-year history average of about 10 per cent. 

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So, it’s easy to see there are some junctures where passive investing is absolutely the right (and more affordable) choice, but perhaps we’re at a juncture now where active investing is again necessary.  

Fast forward to 2019, and the market doesn’t look so inviting. Timing suggests the market is late cycle and investors copped a shaky Q4 correction with 2019 looking to carry that same momentum. 

So, with risk an ever-present factor in investing, what saw the move away from active management in the first place, will it make a heady comeback, and do investors even have to pick sides?

The move away from active investing

We know the GFC caused a lot of investors to become more cautious about their investments and head down the passive route, but the experts suggest it wasn’t the sole (or the biggest) driver. 

An obvious reason for the rise in passive investing is lower fees, but the move has actually proven that money really does talk, and what’s interesting about an uptake in ETFs and passive investing is that it’s been a signal of investors’ preference for transparency. 

Stuart Fechner, director, retail and relationships, at Bennelong Funds Management, said the move away from active investing wasn’t necessarily about the investment fund or the strategy of the passive vehicle, but rather about being relevant to how investors want to implement and manage their money. 

“That is going from that traditional and PDS [product disclosure statement] managed fund structure, to being able to implement or buy and sell online or via the ASX [Australian Securities Exchange],” he said. “And probably especially if you’re talking about self-directed investors of SMSFs [self-managed superannuation funds] for example, they may already have an online account or broker of some type, they’re used to operating that way and hence they want to continue in that operation.”

Fidelity Australia’s managing director, Alva Devoy, agreed that the mode of investing is moving away from the traditional (and opaque) model, to a more open and transparent one. 

“If you think about your own purchasing and the way you like to shop today, you want choice, you want to be able see and compare the costs, and you want things to arrive when they’re supposed to arrive in the condition that you expect them to arrive,” she said. 

“That mode of buying and accessing goods and services is transferring to financial services.”

Active or passive, that is the question

All the experts agree that when it comes to passive and active investing, it doesn’t have to be one or the other.

CEO of BetaShares, Alex Vynokur said there’s space for both active and passive, and investors looking for straight outperformance of a benchmark are missing the point. 

“The whole active versus passive debate misses the bigger picture,” he said. “The point for clients really is getting that asset allocation right and making sure they’re not taking too much risk if they can’t tolerate it, but in some cases if they’re not taking enough risk, taking more.”

According to Vynokur, while active managers can hone in on their particular niche, investors should instead be using ETFs broadly as building blocks to construct cost-effective and robust portfolios, and get the right balance of assets. 

“The mix of growth and defensive can be tailored quite easily using ETFs. An active manager that is a specialist in equities can only play around with the risk they take in the equities portfolio, but the bigger picture that people need to understand is the mix between growth and defensive across equities, fixed income, cash and alternatives,” he said.

Fechner also said there’s always room for both given they’re quite different propositions in the fee sense and the investment strategy that’s involved. 

But, while there’s space for both, active strategies suit particular investors. Investors in retirement phase, for example, need tailored funds to minimise volatility on the downside. 

“You don’t get those specific tailored outcomes of fund-for-purpose from an index fund – there’s no discretion of overweight/underweight certain stocks, you just get what you get,” he said. 

And, if the market plays out anything like the last quarter of 2018 where negative returns kicked in, Fechner said that typically presents greater opportunity for investment managers that are doing the detailed bottom-up analysis on the individual stocks and focusing on their fundamentals to find some decent investment opportunities.  

Devoy said passive plus active is very beneficial to the end investor, because there are points in time where exposure is enough to generate excellent returns, but when periods of volatility arise, active management is set up to avoid investing in blow ups. 

“Active management should be delivering excess returns, should be lowering your risks relative to the index, and should give you a smoother ride so that you don’t feel all of the pain, whereas with passive, you feel every bump – there is nowhere to hide,” she said. 

But, Devoy recognises active management isn’t always accessible to all investors given the fees, which is something that drove Fidelity’s move into the active ETF space. 

Active ETFs

Active ETFs are exactly what they sound like: a complete paradox. But perhaps they’re one of the regulators’ best inventions. 

Essentially, active ETFs make it easy for investors to gain access to actively managed portfolios, bypassing planners and dealer groups, and, ultimately, excess fees. 

Devoy explained the vehicle came about in Australia (and they’re only available in Australia) as the Australian Securities and Investments Commission’s (ASIC’s) and the ASX’s response to a concentration of risk building in investors’, specifically SMSF investors’, portfolios. 

Essentially, even though investors think they’re diversifying their assets from property (given most own a house and/or an investment property) through to stocks and shares, particularly bank shares, their exposure through those shares is generally still to Australian housing, which layers the risk. 

“We have a misstep somewhere in the system, and everything blows up together,” she said. 

To mitigate that risk, Devoy said the regulators came up with a mechanism where fund managers can list their products on the ASX, and a client could buy a unit of their fund in exactly the same way that they buy shares in, say, the Commonwealth Bank of Australia (CBA). 

“They ring their broker, say they want to buy 10 shares in CBA, and that they’d like to buy 10 units in Fidelity’s Australian Equity fund as well.”

While it’s still relatively new to the market, and there’s some education still to happen around the subject, Devoy already predicts it will attract many more investors to the market. 

“You can just see the actual vehicle reduces the friction, reduces the hassle and makes it way easier and way more transparent,” she said. “The more you have line of sight on your total portfolio all in one place, the better your investments become, the more often you’ll want to transact, which can only be a good thing in time.”

The outlook for 2019

While most active managers would quite frequently attest that “this year will be theirs”, the stats show otherwise. 

According to the annual S&P Indices Versus Active report, 70 to 75 per cent of active managers tend to fail to beat their benchmarks (net of fees) over 12 month, three-year, five-year, 10-year and 15-year periods. 

Vynokur said this happens in rising, falling and volatile markets, and while the promise of active management is always there, the delivery of that outperformance is mixed at best. 

“That is probably really at the core of the ongoing growth in the ETF industry, and ongoing growth in index investing.”

So, while active managers may think 2019’s volatility makes them the better choice, Vynokur believes it’s still the combination of passive and active, and the right asset allocations, that will really see investors through. 

True to form, Tagdell, an active manager, said the back half of last year saw volatility pick up, and SGH certainly thinks this year we’re going to be in a period where volatility will remain reasonably high. 

“I think that whilst you might see some recovery in the market, we are late cycle, it’s been 11 years in this cycle, there’s many people talking about a recession, and whilst it’s not our base case that there will be a recession this year, I expect that it will be talked about a fair bit, and there will be periods where the market will worry about that a lot.”

He told Money Management that he liked the energy space, particularly LNG, and the China pollution thematic, which he expects will continue to play out through the course of the year. 

He said the east coast infrastructure thematic looked pretty strong, so stock exposed to that would continue to do reasonably well, but he was cautious on the consumer sectors. 

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"According to the annual S&P Indices Versus Active report, 70 to 75 per cent of active managers tend to fail to beat their benchmarks (net of fees) over 12 month, three-year, five-year, 10-year and 15-year periods."
says a lot.
Hard in Australia for active managers not to follow the Index given concentration in banks and resources.

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