Cherry Reynard challenges the definition of “value” in investment management and argues active investment is a risk worth taking
Time to get active
Why invest? It is a question that would have been unthinkable 10 years ago. People invested because it brought them higher rewards than cash, protected their purchasing power, delivered them a growing income. But volatile markets, economic crises and political interventions have conspired to shift the narrative on
investment. Cash may not pay much, but at least the overall pot remains the same, it is argued. Increasingly, investors are questioning why they should invest at all, whether investment risk is worth taking, rather than simply where they should be invested.
One of the biggest challenges for advisers is to reverse this view. Few investors are likely to meet their long-term goals with a portfolio invested in This supplement aims to help advisers demonstrate to clients why investment, and more specifically, active management, is a risk worth taking.
Part of the problem has been the current narrative on fund management. High-profile spokepeople have managed to reduce the debate to a simple discussion on costs: “value” in fund management has come to mean cheap. Cheap equals good and expensive equals bad.
This narrow definition of “value” has led to the assumption that passive is good and active is bad. Yet passive funds are likely to underperform their underlying index because of the costs of buying. Compounded, this can act as a significant drag on performance. Is this really better value than a strong active manager who strives to protect capital in market sell-offs, to spot tomorrow’s winners and to avoid the “danger” stocks? Over the years, it has been extremely valuable to have an investment manager who could call the top of the technology bubble, avoid BP or skew a portfolio to recovery as the need arose. Investors need to ensure they are truly receiving value, rather than simply paying low prices.
The same spokepeople have also raised questions about the “hidden costs” of fund management. Many have tried to create the illusion of a shady world, lining its own pockets at the expense of investors through higher dealing costs. This ignores the simple fact that active fund management is singularly transparent. If a manager does employ high turnover in a fund unsuccessfully, it is right there in the performance statistics for all to see. Given that fund performance still drives the majority of inflows into funds, it seems self-defeating to engage in high turnover just for the sake of it.
However, there are perhaps some more heart-felt reasons why investors may be reluctant to pull their cash from under their mattresses or prise it from their bank manager’s fingers. The memory of the “lost decade” for equities runs deep. It certainly made good headlines and unquestionably, those who invested as the FTSE 100 neared 7000 in 2000 could be waiting a long time to recoup their money. Yet, this was a unique time in the market - a bubble unprecedented in modern times. The buy and hold investor who invested 10 years ago from today is up about 9.3%. It remains an unimpressive total given the volatility, but it is not a lost decade any more.
Ah yes, volatility. This has been the most uncomfortable area for investors. Most can deal with occasional drawdowns, but they have struggled to deal with the unpredictability. The 40% losses on some asset classes in 2008 were scarring. Nevertheless, the solution taken by many investors, to avoid investment or look to passive strategies, is surely irrational. Volatility has created opportunities. Looking at IMA fund flows, investors have become more savvy at capitalising on market weakness. Money no longer ebbs and flows exactly in line with the highs and lows in markets. Equally, passive strategies are the one way guaranteed to participate fully in the market rollercoaster. There is no qualitative attempt to try to mitigate losses.
“Active fund management is singularly transparent. If a manager does employ high turnover in a fund unsuccessfully, it is right there in the performance statistics for all to see”
However, the current investment climate requires a shift in mind-set on the part of investors. For many years, “buy and hold” was standard investment wisdom, but this view has shifted. Investors - and their advisers - have to be more tuned into the prevailing market sentiment, plus macroeconomic and political movements. While in no way suggesting that investors need to “churn” their portfolios, they have to be more active in their asset allocation and their fund selection in future. Fortunately, this also coincides with a period in which it has become increasingly cheap and easy to move investments. There is also broader asset allocation expertise and detailed fund research available. Either way, it should give investors more incentive to call upon the services of advisers from here.
There is a danger of extrapolating the experiences of the equity market out to wider investment markets. The volatility of the equity market makes headlines, but few talk about the bull market in bonds that has been seen over the past decade. Let us not forget that this is where the majority of investors have had their money. This may now be drawing to a close, but many investors have participated.
There have been some extremely difficult years brought about by a credit crisis of new and frightening proportions, but there has always been something to buy. Looking at the past four calendar years, as the markets have been recovering from the crisis, there are plenty of sectors that have seen only minimal drawdowns in weaker markets and significant rises in stronger markets. For example, all the following sectors have seen drawdowns of no more than 5% on average in any one of the four past calendar years: absolute return, global equity, global bond, global equity income, North America, sterling corporate bond, sterling strategic bond, sterling high yield bond, UK equity income, UK equity and bond income, even technology and telecoms.
This has happened, lest we forget, as the biggest trading bloc in the world - the eurozone - has been on its knees. Also, these are only averages and mask much stronger performance from individual managers. There is an increasingly strong argument for a more active and nuanced portfolio to deal with the current market conditions. Active fund managers in every asset class have the tools to manage through the volatility, yet investors are increasingly favouring passive solutions. The latest quarterly figures show that net retail sales of tracker funds are the highest on record at £661 million.
Again, it is understandable that investors should want to avoid complexity, but the problems with an entirely passive approach have been well-documented. As John Chatfeild-Roberts, head of the Jupiter fund of funds team points out in his book Fundology: “following the herd only works when markets are rising”. If growth in the global economy is likely to be hard-won, with markets volatile but flat in response, a passive investment will make investors precisely nothing. Or rather, nothing less fees. Chatfeild-Roberts points out that wherever there is no qualitative judgement on a portfolio, anomalies are bound to occur.
The argument for passive has been that the right active managers are difficult to find. Yet, Invest is full of high-quality managers, who have been at the helm of their funds for years, delivering consistent, top-quartile performance. Some have had the occasional difficult year, but this should not be used to condemn all active management. After all, the active manager can learn from a bad year and use it to improve performance in future.
“Active managers may not always outperform, but at least they have the capacity to do so”
As many of the skilled fund selectors on pages 14 and 15 point out, it is simply a case of knowing your manager, knowing the type of markets in which they will perform and which markets may not suit them. Active managers may not always outperform, but at least they have the capacity to do so. Again, fund manager performance is extremely transparent, so investors should know whether they are with a leader or a laggard.
The active fund management industry has strength and depth, as this supplement shows. Inside you will find some of the strongest talent the industry has to offer. If nothing else, it should be a wake-up call for those sold on the easy arguments of a few media pundits. Active management has an important place in helping investors build for the future. They neglect it at their peril.
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