The times may suit active management

Despite ongoing fee pressure and competition from passive managers and exchange-traded funds (ETFs), which recently benefitted from relatively low volatility levels, it looks like active managers have begun to see the first signs of a reversal in trends.

Although the aftermath of the global financial crisis saw investors flocking into passive investing and away from active management, managers believe the market environment has begun to change, with market volatility expected by many to pick up.

This view was reinforced by a recent survey from BlackRock which examined 224 institutional clients globally and found they were selectively increasing allocations to active strategies in order to protect themselves against downturn risks when faced with low interest rates and relatively high valuations for risk assets.

The last decade also offered a more favourable environment for passive investment but going forward higher volatility would help active managers to regain their momentum, they said.

SG Hiscock portfolio manager on the Australia Plus and SGH20 Funds, Hamish Tadgell said: “These things tend to go in cycles a bit, and clearly passive has seen a very strong following and very strong flow of funds over probably the last decade.”

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He added: “We run a high conviction fund and active management is all about a strong belief that at the end of the day the market is not efficient and [that] we think that with a disciplined approach and experienced managers, you can outperform the index.”

Of a similar opinion was Bennelong Australian Equity Partners’ (BAEP) investment director, Julian Beaumont, who noted that once market momentum stopped going up, active managers would come to the fore: “Active management is largely about risk management whereas passive investing really draws momentum from the market itself,” he said.

The Bennelong Concentrated Australian Equity Fund returned 19.98 per cent over a three-year period to November 2017, according to FE Analytics, which placed it as one of the top performing funds across the Australian Equities asset class over that time period.  The fund invested primarily in companies selected from, but not limited to, the S&P/ASX 300 Index, and charged a management fee of 0.85 per cent. The fund’s total management cost for FY17 was 1.41 per cent inclusive of a performance fee.

Furthermore, according to AMP Capital’s senior portfolio manager and fund manager of the AMP Future Directions Bond Fund, Lydia Serafim, particularly at this late stage of the business and credit cycle active management is at its most critical and necessary.

“In the credit landscape, increasing idiosyncratic risks and growing dispersion amongst the quality of institutions and their underwriting (particularly for sub-investment grade corporates and commercial real estate) has meant that active management is a must, and will protect investors when the inevitable credit repricing occurs,” she said.

At the same time, on the rates front, the somewhat global synchronisation of monetary policy and rates meant that inter country and curve strategies were necessary to not only improve, but preserve performance, according to Serafim.

The AMP Future Directions International Bond fund delivered annualised returns of 7.5 per cent over the three years to November, 2017 against its benchmark, Index Bloomberg Barclays Global Aggregate, which returned 5.71 per cent, FE Analytics showed.

VOLATILITY

According to managers, rising volatility was expected to be one of the key factors driving interest in active management strategies. 

Beaumont stressed that volatility would be very helpful for active managers as it would create opportunities in terms of both buying and selling.

He also explained that the crucial role for active managers and potential opportunities, but at the same time one of the key challenges, was outside the top 20 stocks. He said these stocks were typically less researched and required a higher degree of expertise.

“At least in the Australian market you’ve got a large part of what is given to passive investment and that is the top 20 stocks and that is the banks and resources and mining,” he said, adding that all these sectors recently struggled to deliver as attractive returns as what could have been found “further down the market.”

According to him, this helped explain investors who were getting away from passive exposure in order to get into “more exciting parts of the market.”

“Over time, active managers have outperformed not in respect of the top 20 but further down and the further down you go the more expertise and risk management is required,” he said.

PRODUCT DEVELOPMENT

According to the Betashares Australian ETF Review – 2017 in Review report, although the number of new product launches (31) was somewhat lower in 2017 than the year before (40), with three products being closed, 2017 still saw 226 exchange traded products trading on the Australian Securities Exchange (ASX).

Over past years passive managers have also developed a reputation as being excellent advertisers of their products and they quickly gained fluency in marketing them. At the same time, it was widely debated why active managers, who typically charged higher fees, struggled to outperform the market.

Although the BetaShares’ report called the situation in which product development numbers in 2017 were lower than in 2015 and 2016 “rather striking,” it also said it was unsurprising as the trend represented an indication of the industry’s maturity.

However, BetaShares predicted that 2018 would continue to see strong product development.

With the ongoing push from the regulator towards greater transparency around costs and fees, active managers often also attracted some criticism around delivering actual value to investors which in turn brought a question of what constituted the successful active manager.

According to Tadgell, active management was about running a concentrated portfolio with a high active share as well as developing a disciplined and repeatable process run by experienced managers.

“We would hold the view that running active, true active – you really need to look at the active share – of funds and the active share is really about how much your portfolio differs from the benchmark,” he added.

According to FE Analytics, the SGH Australia Plus Fund delivered annualised performance of 19.56 per cent over three years to December, 2017, positioning itself as one of the top performers across the Australian equities asset class. The fund, whose objective is to outperform the S&P/ASX 300 Accumulation index by five per cent over a rolling three-year time frame, charged a total management cost of 0.7 per cent with the initial investment for the fund at $20,000.

SECTORS 

As far as market sectors were concerned, the majority of active managers stressed that they were more stock specific. Instead of tracking any general market themes they tended to look at the individual stocks rather than sectors.

“We are sort of sector agnostic, and we look at the entire market,” Tadgell said.

“In Australia we look at ASX 300 and we’re really trying to identify 25 stocks which we think will outperform the market on three to five-year period.” 

In terms of the companies and their quality, he said the fund would look at things like the sustainable and growing free cash flow, how well it was positioned and attractive in the market as well as the companies that were growing in the markets but could prove at the same time that they were sound and well-structured.

Although, Tadgell said, it wasn’t the function of the sector and buying stocks but rather about the bottom-up process. He mentioned healthcare as an example of a sector that fund managers might be attracted to, given its historical growth of above GDP as well as the benefit of aging demographics.

However, Tadgell warned that it was also a sector with high regulatory risk at the moment.

“It’s the sector which has also a lot of regulation risks we’re still overweight to healthcare but we’ll probably lower exposure to the healthcare that we had for probably for six – seven years just because we see sort of high regulatory risks in that sector at the moment.”

According to SG Hiscock, Australian banking was another example of a sector which represented similarly high regulatory risk.

“In Australia we’ve probably been underweight Australian banks, it’ll be another sort of consistent theme. It’s probably the function of the banks are 25 per cent of the market in Australia and we are running a 25 stock portfolio so we are not going to own all four banks,” he said.

CHALLENGES AHEAD

According to AMP Capital, the general challenge over 2017 was low volatility and therefore ability to tactically benefit from positioning as well the way global markets were dealing with declining, albeit ongoing, monetary policy.

“On a business front, active managers are needing to deal with ongoing fee pressures and competition from passive fund and ETFs,” Serafim said.

She also expected more consolidation going forward as well as increased interest in the environmental, social and governance (ESG) and factor investing.

For Perpetual Private’s senior research analyst, Hugo Agudo, navigating through the geo-political risks and their implications for the markets that would remain one of the key challenges. 

“Interesting will be the US with their tax changes and how that will affect the cash flows in corporates,” he said.

“In terms of the Wholesale Alternative Income Fund, we’ve probably had a bias to Europe, and will probably add more in the US,” he said.

“In terms of our normal Fixed Interest fund, we try and stay fairly conservative, we do have some emerging markets exposures. I couldn’t see us bias to anything else in the portfolio.”

Adago also said that the fund had some exposure to emerging markets, such as Brazil and Mexico, which looked attractive if investors should remain cautious, and might represent a good opportunity to add some volatility to portfolios.