Active managers: Market turmoil provides opportunities to shine

Updated with correction

Despite rough-and-tumble markets since the COVID-19 pandemic began to impact global markets in February, some active U.S. equity managers, especially those running growth strategies, are moving quickly to snap up investment opportunities thanks to rock-bottom stock valuations.

Market conditions in the quarter ended March 31 wreaked havoc on the returns of active U.S. equity managers and was especially grueling for value managers, Pensions & Investments' analysis of returns of active U.S. equity mutual funds of the 10 largest mutual fund companies showed.

The average excess return of actively managed U.S. equity growth mutual funds over individual fund benchmarks in P&I's universe was 1.4 percentage points in the first quarter. Blended U.S. active equity funds had average underperformance of fund benchmarks of 1.3 percentage points, while value funds produced average underperformance of 3.7 percentage points compared to fund benchmarks.

The S&P 500 index was down 20% in the three months ended March 31.

Despite the optimism of active U.S. equity managers about improving prospects for their investment portfolios, performance and asset growth, a wide swath of long-only active managers still face endangered species status, said Kevin P. Quirk, a principal of Casey Quirk, a Deloitte Consulting LLP business who is based in the firm's Stamford, Conn., office.

"Not much will change even if the performance of active managers improves, not over just a quarter, but over a cycle," Mr. Quirk said.

The firm's data shows that just 23% of active equity managers worldwide that invest in publicly traded markets, representing 41% of total assets under management, consistently deliver excess returns.

With the majority of actively managed equity assets flowing to the small cadre of "really good active equity managers (that) will become very wealthy" and passive management continuing to be a "very viable option" for many investment clients, Mr. Quirk predicted that "mediocre managers who don't distinguish themselves in this opportunistic market face wash out."

After a decadelong bull market, characterized for the most part by low volatility, sources said active U.S. equity managers finally have what they need to differentiate themselves from other active peers and outperform passive managers.

"The path forward has so many rabbit holes that it's hard to predict when the market will hit bottom and recovery will begin, but significant volatility allows active managers to take advantage now of dislocations," said Christopher M. Riley, partner and head of global equity research at Aon Investments USA Inc., Chicago.

"In the ashes and smoke, we are seeing some active U.S. equity managers that are producing really great returns so far this year by buying securities of high-quality companies" with valuations that have sharply declined, Mr. Riley said.

"Being nimble shows how active managers create good long-term value during a period of disruptions. We are seeing strong performance so far this year among active managers investing in some pockets in the market. Relative to passive management, some of these managers look pretty good," Mr. Riley said.

He declined to provide manager names.

Jackson Square Partners LLC, San Francisco, is on what its chairman considers a buying spree.

"This is a remarkable opportunity for active managers to better position their portfolios," said Jeffrey S. Van Harte, a partner and the firm's chairman and CIO. "There's been a huge sell-off, massive volatility and extreme dislocations and there are opportunities across all sectors. If you're an active manager, this is an incredible market."

The firm runs concentrated portfolios with very low turnover, but the six investments made in new U.S. companies over the last few weeks represents "the largest turnover we've had in years. We bought companies we've always wanted to own, but were too expensive," Mr. Van Harte said.

Among the sectors Jackson Square Partners likes right now is the software-as-a-service market. Companies in that sector are profitable, have strong client bases as well as huge markets and "rarely go on sale because of their intrinsic business value. You have to act fast," said Jackson Square's William G. "Billy" Montana, partner and large-cap portfolio manager.

Mr. Van Harte declined to provide the names of the stocks the firm has recently bought or sold.

Jackson Square Partners managed $19.8 billion in active equity strategies as of Dec. 31, of which $15.6 billion was managed in U.S. equities.

T. Rowe Price Associates Inc., Baltimore, "always adds risk assets when everyone else is fearful. We have a two-year horizon, not a two-day horizon," said David R. Giroux, head of investment strategy, CIO-equities and multiasset, and portfolio manager of the firm's $56.4 billion Capital Appreciation Fund.

Mr. Giroux's portfolio combines a core active U.S. equity strategy with active bonds and cash. Once the market began to slide in response to the coronavirus outbreak, "we really pumped up equity in the portfolio because of the substantial upside opportunities for managers who are buying now and holding," Mr. Giroux said.

The portfolio's allocation in January was 56% equities, 25% bonds and 19% cash. As of March 26, the portfolio allocation was 71% equity — "we are funding a tremendous number of great ideas," Mr. Giroux said — 27% bonds and 2% cash.

T. Rowe Price managed a total of $1.21 trillion as of Dec. 31, 95% of which was actively managed. About 80% of assets were managed in active equity strategies and of that, the majority was invested in U.S. equities, mostly growth stocks.

Active managers of U.S. growth stocks likely will to continue to outperform value managers through the down-market phase of the current financial crisis, sources said.

"Growth is having a good run because manager portfolios are less levered to the economy and tend to be invested in big digital companies like Amazon.com Inc. and NetFlix Inc., which cater to consumers, as well as defensive stocks in sectors such as food production, consumer staples, REITs and utilities," said Saira Malik, senior managing director, CIO and head of global equities who is based in Nuveen's San Francisco office.

One such company is Booking.com, a subsidiary of Booking Holdings Inc. The firm is a large travel booking company that's "asset-light" without physical assets and no fixed costs, Ms. Malik said, and likely will partner with hotels and restaurants after the current travel slowdown and shelter-in-place orders are over.

Ms. Malik said value strategies, on the other hand, "were really hit hard by the downturn" because the focus of many managers is on investment in the financial, energy and industrial sectors," which have performed poorly since the coronavirus problems emerged.

However, once the markets begin to recover, value managers "will have a really good rally as the market improves and the focus changes to quality companies," Ms. Malik said.

Nuveen managed a total of $1.1 trillion as of Dec. 31, of which $196 billion was managed in active U.S. equity strategies. The breakdown by strategy was $72 billion in growth equities, $30 billion in value strategies and the balance in core active equity approaches.

Despite growth managers' performance edge in the tumultuous prior quarter, active value-oriented managers aren't idle.

Epoch Investment Partners Inc., New York, focuses on the free cash flow of companies that are profitable and is not waiting for a post-crisis rally to buy great companies at good prices.

Within classic value sectors such as aerospace, leisure, travel and food, Epoch has been buying new names over the last few weeks, including The Boeing Co., said David N. Pearl, executive director, co-CIO and portfolio manager.

"We're bottom-up investors," Mr. Pearl said. Before investing in Boeing, he noted that the firm's investment team analyzed the company's cash flow and found that there's enough on hand for the firm to survive for a year, even without an industry bailout.

Mr. Pearl said other new names in Epoch's portfolios include Martin Marietta Materials Inc., a concrete, asphalt and aggregates maker that will benefit from post-crisis infrastructure buildin, and DropBox Inc., which will likely see good profitability from the likelihood that many people will continue to work remotely after the crisis.

Even with the confidence Mr. Pearl has in these and other new investments, coupled with the firm's three-year investment horizon, he did admit that "you really have to close your eyes until the virus crisis is over."