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Why active management has turned a corner, according to Psigma’s Becket

21 July 2017

Tom Becket, chief investment officer at Psigma, explains why he expects passive vehicles to struggle and actively-managed funds to thrive in today’s difficult climate.

By Lauren Mason,

Senior reporter, FE Trustnet

Active funds have turned a corner following disappointing returns in 2016, according to Psigma Investment Management’s Tom Becket (pictured), who now expects them to thrive while passive vehicles struggle to keep pace.

The chief investment officer has long been an advocate of blending active and passive strategies, but adjusting the allocation depending on market sentiment.

Now, given the potential for central banks to unwind their balance sheets, as well as the increasing polarisation between individual stock performance, he believes previous headwinds faced by active managers have now started to give way.

“Of course it is premature to state it conclusively, but the first half of 2017 might well have seen the start of a revival or a renaissance for active equity funds in the UK,” Becket wrote in his latest blog post.

“The cynics (me amongst them) would say it was long overdue after a mostly dismal 2016 (and in some places over the longer run), but there are signs that a corner has been turned.

“Given the major structural pressures faced by the active management industry, such as the growing fashion of passive investing, the lack of wealth creation in the UK and the increasing challenge that many asset managers have in growing assets, the relief that a change in fortunes might be here is palpable.”

The CIO said 2017 has provided a richer hunting ground for investors, given that 191 out of 264 funds in the IA UK All Companies sector – or 72.3 per cent – have outperformed the FTSE All Share index so far this year to the end of June. In contrast, just 42 out of 259 – or 16.2 per cent – of funds in the sector managed to achieve the same feat throughout the course of 2016.

Data from FE Analytics shows that the average fund in the sector underperformed the index by 5.92 percentage points with a return of 16.75 per cent (this should be caveated with the fact Psigma generally chooses not to use sectors to assess fund performance but is doing so in this case as a ‘preliminary guide’).

Performance of sector vs index in 2016

 

Source: FE Analytics

Even including 2017’s stronger results and looking over an 18-month time frame, Becket pointed out that only three out of 10 funds in the sector have managed to recover lacklustre 2016 performances to beat the index.


“Consistent performance has been hard to achieve and given the flip-flopping and vicious rotations in markets, the 8 per cent of managers who skilfully beat the index in 2016 and 2017 should be applauded,” he continued.

“To be frank, given the major rotation in the fortunes of various themes, sectors and companies over the last eighteen months, a fund manager would have to have been consistently selecting some specifically poor companies (UK retail/consumer cyclicals an obvious issue) or totally timed rotations badly to have consistently underperformed in both 2016 and 2017 to date.

“Again, using the UK All Companies sector, only 54 of 259 funds lagged the benchmark in both 2016 and 2017 YTD, respectively, and our qualitative analysis suggests this is mostly down to errant stock picking.”

According to Becket, weak relative returns from actively-managed funds began between the end of 2008 and the start of 2009 amid the “explosion” of the US Federal Reserve’s (Fed’s) balance sheet.

As quantitative easing programmes expanded exponentially, the CIO said every asset’s value began to rise simultaneously.

“In layman’s terms, the pumping of trillions of dollars of liquidity into the system has fuelled a ‘rising tide floats all boats’ rally,” he explained.

“We could, therefore, be at an interesting juncture in this story if you take Fed chair Yellen and her cronies at face value and believe that they are close to starting to unwind their swollen balance sheet.”

Not only this, Becket said there is a greater level of bifurcation between stocks that perform well based on positive earnings announcements and stock that suffer when they miss their earnings targets.

“As simple as this may sound, this has not always been the preeminent driver of outperformance over the last few years to today, in our opinion, as fund flows and every morsel dropped from the mouth of a central banker have driven overall market performance and individual companies’ share prices,” he reasoned.

The team at Psigma therefore believes the asset management industry will undergo a significant period of change, whereby lower returns and shrinking profit margins will continue to fuel the desire for passive vehicles.


However, Becket believes this could be a mistake as the tapering of quantitative easing and high valuations could weigh heavily on indices.

“Our view has always been that investors should mix passive and active equity exposure, but rotate the allocation to each depending on your outlook,” he explained. “This is becoming an increasingly common view, and it would appear highly likely that many multi-asset portfolios will be built with a passive equity core and a smaller number of highly active funds to create specific biases.

“Indeed, the future for ‘index plus a little’ type strategies with low tracking errors is likely to be poor, as investors shun the relatively high fees (over passive) and lack of a story for end investors. In fact, I would go as far to suggest there is no real future for such strategies.”

As buy lists become increasingly aligned and as investment processes consolidate, the CIO also predicted that investors will flock to ‘star managers’ and will therefore create distortions in the market.

As investors base their decisions on past returns, he warned this trend could self-perpetuate and cause funds run by celebrity managers to grow further.

“We already live in a world where fund selectors are reticent to seed new funds or back smaller funds and an exacerbation of this trend will be that new entrants will find it harder it even harder to raise money and make their businesses a success,” Becket said.

“So, while asset managers with active equity funds will celebrate a return to better performance over recent months and we expect this trend to continue, it might well be that only a few benefit fully from improving fund flows in the future.”

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Data provided by FE fundinfo. Care has been taken to ensure that the information is correct, but FE fundinfo neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.