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Some seeing a new cycle back to active

Dismal market forecast could be major impetus

Luba Nikulina
Luba Nikulina sees people being more open to active management.

The tide might be turning for active managers, as dispersion creeps back into global stock markets and investors realize their long-term return assumptions just won't cut it going forward.

Sources at money management firms and investment consultants said a new cycle is emerging, with clients' interest in active management piqued by challenges in the markets.

While there is not yet a tidal move toward active, “there is definitely an early sense that people have become a bit more open to having this conversation (about active management), and we just don't have doors shut in our faces when we start talking about active strategies,” said Luba Nikulina, global head of manager research at Willis Towers Watson PLC in London.

A number of institutional investors are considering the case for active, particularly in relation to long-term investment. Speaking at the Pensions & Investments WorldPensionSummit conference in The Hague, Netherlands, this month, Ronald Wuijster, chief client officer at APG Asset Management, based in Amsterdam said: “Passive is passť - you need to be active, and you need to be active in many ways.” (See related story on page 20.)

Long-term investing is about active ownership, identifying the underlying factors of investing, engagement and trends — “passive investing is far away from long-term investing,” Mr. Wuijster said. APG has €444 billion ($481.8 billion) under management, including the €376 billion in assets of ABP, Heerlen, Netherlands.

PGGM, which runs the assets of the €185 billion Pensioenfonds Zorg en Welzijn, Zeist, Netherlands, has not materially changed its stance on the active vs. passive debate. “Most of our clients have passive investment beliefs, mostly from the perspective of cost effectiveness and being in control of the portfolio,” said Sander van Stijn, lead investment consultant at PGGM Fiduciary Advice in Zeist. Still, management is not purely passive — active decisions are made in benchmark construction, and investment managers have “a fair bit of room ... to intelligently deal with benchmark changes.”

However, PGGM is discussing with its clients how to focus more on the long term when it comes to managing portfolios. It is considering how best to facilitate that: “By thinking very differently with respect to the benchmarks we use, or is it better to give more along the lines of active management? It very much depends on the asset class or purpose of the investment mandate,” added Mr. van Stijn.

Fundamental factors

Investors opting for active management might be supported by fundamental factors. “Market volatility is increasing, which creates that macro case for alpha, (as well as) valuations around the world, where the opportunity for pure upside just from passive investing is brought more and more into question,” said Ms. Nikulina.

Recent market events are also supporting the case for active management. Donald J. Trump's victory in the U.S. presidential elections, “genuinely a bit like Brexit, has put a whole lot of uncertainty into how the economy, monetary policy, fiscal policy and therefore the markets may now perform,” said Neil Dwane, London-based global strategist at Allianz Global Investors. “Lots of people are looking at the headlines, but I don't feel (they) are looking then at the substance or difficulty with which some of the headlines will be implemented. That is to some extent where active managers can sit there and sell the rumor, buy the fact.”

Regarding Mr. Trump's policies, the impact on different parts of the stock markets is unclear. “We don't want to sit there in an index — because we will do up and down for reasons we cannot anticipate,” added Mr. Dwane.

Market fundamentals have hit active managers hard in the years since the global financial crisis. Dispersion — the variance in returns among stocks — has been low, meaning even capable active managers have been unlikely to outperform. “It has been a depressing era for skillful people,” said Tim Edwards, London-based senior director, index investment strategy, at S&P Global. “But it looks like we are coming into a different era and environment.”

Mr. Edwards said there was an incipient trend evident before the U.S. elections of dispersion reappearing in even the most notoriously difficult of stock markets for active managers to set themselves apart from the passive strategies. Dispersion among Standard & Poor's 500 index stocks is “at its highest since the crisis, and is very high elsewhere,” said Mr. Edwards. Data from S&P show this dispersion at 29% as of Nov. 16, compared with 19% as of Oct. 31.

While active managers will still have to make the right bets to be successful, those same positions will have bigger outcomes because of the increased dispersion. “It is an environment that gives skill an opportunity to shine,” added Mr. Edwards.

Structural forces

Celia Dallas, Arlington, Va.-based chief investment strategist at Cambridge Associates, said market capitalization dispersion is one of the most important structural forces that comes into play in determining the percentage of managers outperforming their benchmarks. “Active managers tend to hold more equal-weighted portfolios than the market-cap weighted indices, so there is a structural bias toward managers outperforming when the equal-weighted index outperforms the cap-weighted index,” she said.

Since 1980, in 86% of the years when the equal-weighted S&P 500 has outperformed the cap-weighted version , the median active U.S. equity manager with a mid- to large-cap bias has beaten the index.

However, the median active manager has underperformed the index in 71% of years in which the cap-weighted S&P 500 has outperformed the equal-weighted index. “The higher the magnitude of difference, the more influential the relationship,” said Ms. Dallas.

And should history repeat itself, active managers will be in for a good year. “So far this year, the equal-weighted S&P is outpacing the cap-weighted index by 273 basis points through Sept. 30, and 346 basis points through” the Nov. 17 close.

The continued search for yield is also a potential boon for active managers. Ben Gunnee, head of fiduciary management for the U.K. at Mercer Ltd., London, said the continued diversification of assets in the search for yield, such as multiasset credit and absolute-return fixed income, “don't really lend themselves to passive management.”

And for other asset classes, long-term return assumptions are diminishing. “Markets are quite fully valued on an historic basis, and therefore (consultants and trustees) are questioning how much more beta we can get from the markets. It is probably limited going forward. If you want to keep levels of returns up, you are exploring probably a combination of alpha plus beta. Alpha is, and will become, more important as asset class beta moves lower.” Mr. Gunnee added that the increased governance afforded by outsourced CIO arrangements, is also positive for active management since this can allow for increased manager and strategy selection.

Executives at consultant Stamford Associates Ltd. have always been advocates of active managers. However, Nick Wyld, London-based investment director, said “renewed interest in active stock picking” due to the expectation of a lower-for-longer return environment. He also expects credit to become a more significant part of asset allocations “for trustees in achieving their objectives. And in credit markets where managing default risk is core, that has to be active management to us. It may be that recent events are turning investors' ways of thinking,” said Mr. Wyld.

Allianz's Mr. Dwane agreed that fixed-income markets may be where active comes into its own. “When people look in the rearview mirror they are still quite comfortable with the types of returns their fixed-income portfolios have been making — even with the Trumpish wobble we have seen, fiscal policy, yields steepening and trillions of bonds negatively yielding. But if people cannot hold these bonds to maturity that will be a great capital loss.

This article originally appeared in the November 28, 2016 print issue as, "Some seeing a new cycle back to active".