Active managers have the ability to outperform in 2017 given the potential level of uncertainty in markets, according to JP Morgan Asset Management chief marketing strategist Stephanie Flanders.
Flanders says top-down investment strategies may struggle in the current market cycle as a result of political unpredictability, including the inauguration of populist US president-elect Donald Trump and the start of Brexit negotiations.
She said: “When I took this job I said ‘You do realise I come from the economics profession and the economics profession is not necessarily a great believer in active investing’.”
“I have always been quite clear that I thought there was a space at different times in the cycle and in different parts of your portfolio for both passive and active.”
“But at this stage in the cycle I do think you’re not necessarily talking about simple asset allocation choices or index level choices when it comes to countries or even sectors outperforming.”
While much of the uncertainty has so far been priced into the US and UK blue chip markets, which have continued to climb more recently, both could see further instability in the near-term.
Performance of MSCI AC World index in 2016
Source: FE Analytics
Indeed, last year the MSCI AC World index rose by 28.66 per cent, the best calendar year performance since the financial crisis and the third least volatile over the previous nine years.
“We only tend to see volatility peak at the time of big market turns and particularly downturns,” Flanders said.
“The period just before the financial crisis was a period of extraordinary low volatility and last year we did not see volatility that you might have expected from Brexit and Trump – it [the response] was very unidirectional.”
“I think there could be this much more granular variation in performance and unpredictability even at the level of individual companies that we are all going to be dealing with but clearly does offer some potential for bottom-up investors.”
As a result, 2017 looks set to be a more volatile year for markets and, going further down the market cap spectrum, for individual companies. Below Flanders outlines how companies in each region could be affected.
US
One of the biggest issues for Flanders (pictured) is Donald Trump’s approach to politics, consisting of late-night tweets sent to companies including Ford pressuring it to move its manufacturing plants from Mexico – something the company has since done in favour of a site in Ohio. 
“You’re actually talking [about] who is Donald Trump going to ring tomorrow?” Flanders said. “Will it be this manufacturing company or that manufacturing company? Whose three-year location strategy is going to be affected by a tweet that he makes at midnight the night before?”
“You’ve got much more idiosyncratic variants that could make markets move and affect the performance of individual companies.”
However, she adds that part of the lack of movement in markets so far has been uncertainty over what Trump’s presidential style will be: “We don’t know whether he will carry on with this somewhat arbitrary approach to Ford and other people.”
UK
“You could argue that Brexit offers pretty much the same sort of radical uncertainty [as Trump’s election],” Flanders said.
“It’s not just that we don’t know what sort of transition deal there will be or when exactly Article 50 is going to be triggered, a lot of rules across the board are being torn up with a lack of clarity over what’s going to replace it.”
She says investors can no longer make sector calls as minor details of the negotiations may affect different companies within the same sector in different ways.
“Will there be a good deal for financial services? You can’t just talk about financial services you have to talk about which bits of financial services. Is it retail? Is it investment banking? Is it insurance?” she said.
“For every one of those sectors there could be completely unexpected implications of the twists and turns in these negotiations and the length of the transition period.”
Eurozone and emerging markets
Unlike the US and UK, macro signals in the eurozone and emerging markets have been mixed for some time and it is this that allows active management to outperform.
Flanders said: “It’s a consistent story that I tend to be quite downbeat on the macro for the eurozone but there’s plenty of companies that have outperformed.”
“Even within the financial sector there are companies like Danske Bank or financial services companies in Italy which have done fantastically well, even though they are in Italy.”
“The eurozone is where you will see the most [outperformance] and in emerging markets it is always the case that active probably has a better role to play, but in Europe I see it more and more.”
Flanders points to the JP Morgan Europe Dynamic ex UK fund as an example of how this strategy can work for active managers.
The five crown-rated fund has been the fourth best performer in the IA Europe ex UK sector, returning 124.35 per cent over the last half a decade.
Performance of fund vs sector and benchmark over 5yrs
Source: FE Analytics
“Our main European fund has done extraordinarily well over the last five years completely ignoring the gloomy economists and looking at the individual companies,” she said.
“But it may be more true in the future in the US and the UK because of the uncertainty of all these things. It’s fairly speculative but I think this radical unpredictability gives more potential for active managers to be on the right side of that.”
Overall
Flanders says while it is “a safe call to say that we are going to get more volatility because there’s all this uncertainty,” investors and to a certain degree fund managers are yet to fully comprehend that these upcoming events will have more of an impact at the corporate level than ever before.
“I think, particularly in this environment, you’ve got this radical uncertainty that is even affecting individual companies and I don’t think people have quite grasped that,” she said.
“Even some active managers may not be great at it but at least they have a scope for responding.”
“We are all learning this new environment so its not necessarily that fund managers are going to be able to get a handle on these changes immediately, but I think already anybody who is looking at a company level is going to be in a better position than someone who thinks you can just easily make sectoral or country level plays on the back of this.”