Outperforming against benchmarks and stock markets are one of the primary goals for active managers, working to make their fees value for money. But this is becoming particularly challenging in recent years, as seen the rising popularity of passive vehicles that largely aim to replicate benchmark or index returns.
The rise of passives and the sheer volume of money they have deployed has made it increasingly difficult for active managers to outperform, according to GAM Investments’ head of multi-asset solutions Julian Howard.
“Outperforming any index over a sustained period of time is notoriously hard, particularly when it involves equities, where the number of market participants is high and volumes are enormous,” he said.
Such volumes have made the US and – to an extent – global equities notoriously tough for active managers to beat, he said.
As the chart below shows, over the long term the average IA North America peer has failed to outperform the S&P 500 index, the US blue-chip index and a popular benchmark for US equity managers.
Performance of sector vs index over 10yrs
Source: FE Analytics
Howard, who oversees the $1bn GAM Star Composite Global Equity fund along with Sandro Cerulli, said that even factor-based strategies have failed to outperform the broad market more recently.
Indeed, the multi-asset manager said the proliferation of style-based managers and the explosive growth of exchange-traded fund (ETF) market have eroded the ‘edge’ that active managers used to have which kept them ahead of markets.
This can be seen in the performance of the value style that has now displayed no outperformance of the growth style since 1994.
Howard said that outperformance of benchmarks required some anticipation of structural growth trends and, as such, highlighted three that could be help investors.
Technology
Whilst not a new phenomenon the impact of technology on the stock markets has been somewhat remarkable in recent years leading markets higher.
As the below chart shows, the Nasdaq Composite – where technology stocks make up almost half of the index – has significantly outperformed the blue-chip S&P 500 index over the past 10 years (price return in US dollars).
Performance of indices over 10yrs
Source: FE Analytics
Cisco – an American multinational technology conglomerate – estimated that at least 40 per cent of all businesses will not survive if the new technologies are not embraced, said Howard, creating a bifurcated world of winners and losers, although both could offer attractive opportunities for outperformance.
“Admittedly, this is hardly new thinking,” said the multi-asset manager, and as the TMT (technology, media, telecommunications) bubble of the early 2000s showed the sector is prone to over-valuation.
“But technology stocks tend to be cash-rich and enjoy higher cash glows than most other businesses, suggesting that adjusted for this higher cash rate, valuations are not much higher than that of the rest of the market.”
He added: “Given the choice between stocks which will lead the coming digital transformation versus stocks that might or might not succeed in embracing it, technology remains a compelling megatrend.”
Sustainability
Support for sustainable investment strategies has been a key theme in the industry in recent years, as a strong consensus builds around sustainability and equality and the need for action.
“Climate change is considered no less than a global emergency by the millennial generation while attitudes to meat consumption and inequality of opportunity are rapidly changing,” he said.
Indeed, sustainability has grown from a sub-sector to the point where firms not seen to be improving on environmental, social & governance (ESG) criteria will likely underperform or be unable to list and raise capital in the first place, said Howard.
As such, the GAM manager said he believes investors can use indices built using ESG criteria to create a structural, long-term overweight of companies scoring highly on those measures to capture their upcoming future outperformance which will happen as the world’s demand for sustainable options grows.
Emerging markets
The final megatrend highlighted by Howard is emerging markets, as the faster-growing economies are underrepresented in major benchmarks.
Despite emerging and developing economies representing almost 60 per cent of world GDP (gross domestic product), Asia and emerging market stock “barely” make up 16 per cent of the MSCI AC World index – a blended benchmark of developed and emerging market stocks.
As such, investors need to take more emerging market exposure, but this too could be a challenge.
“Many investors will likely simply choose an established index such as the MSCI Emerging Markets index to do this but we believe it is overexposed to ‘factory Asia’ and underexposed to fast-growing economies found in Africa,” he said.
The GAM multi-asset solutions head said investors can make further gains by ensuring a suitable exposure to frontier markets, which are even less developed than emerging markets.
“While the last couple of years have hardly been a good advert for emerging markets amid trade wars and a stronger US dollar, they do at least offer an attractive entry point in a way that technology stocks cannot,” he added.
“The megatrends described above are neither universally new, nor universally cheap,” said Howard. “Furthermore, they do not represent a shortcut to near-term index outperformance.
“But what we believe they do offer is access to secular and structural growth stories which transcend near-term market histrionics.”
He concluded: “Investing for megatrends is no less than a viable style in its own right and one which we feel intuitively offers at least as compelling a prospect for long-term outperformance as any other factor or style available to investors.”
Performance of fund vs benchmark over five years
Source: FE Analytics
Since Howard joined the $101.1m GAM Star Composite Global Equity fund in April 2016 it has made a total return of 46.28 per cent, against a return of 62.04 per cent for the MSCI AC World index and a 55.32 per cent gain for the average IA Global peer. The fund has an ongoing charge (OCF) of 1.41 per cent.